US Dollar Forecast: Yields, Inflation, Fed Taper Debate Are Key

Dollar, Money, Cash Money, Business, Currency, Finances

US DOLLAR FUNDAMENTAL OUTLOOK: TREASURY YIELDS, INFLATION, FED TAPERING IN FOCUS

  • US Dollar weakened another -0.3% on balance last week as bearish conviction dominates
  • FOMC officials are creating headwinds for Treasury yields with transitory inflation rhetoric
  • Risk to US Dollar outlook seems tilted to the upside while the Fed taper debate intensifies

US Dollar selling pressure prevailed last week and left the DXY Index -0.3% lower on balance. The US Dollar weakened across most major currency pairs including EUR/USDUSD/JPYGBP/USD, and USD/CAD. This likely followed the decline in ten-year Treasury yields, which occurred in spite of Fed taper talks growing more heated amongst market participants.

Federal Reserve officials are doing their best to stay patiently accommodative and let inflation overshoot the central bank’s 2% target in the near term, labeling it as transitory and in alignment with its recent shift to average inflation targeting (AIT). Although, it is prudent to remember that the market has a mind of its own and is apt to price in (i.e. front-run) potential Fed policy changes.

This has already led to occasional bursts of US Dollar strength. With USD bears arguing that the Fed’s pursuit of making “further substantial progress” warrants the commitment to a dovish stance, however, these waves of US Dollar demand have been faded and short-lived.The ongoing tug-of-war match between US Dollar bulls and bears has strong-armed the DXY Index -4% lower from its 31 March swing high, but considering subtle hints that the Fed has already started to discuss the idea of tapering, there could be potential for the Greenback to find support around current levels.

TREASURY BOND YIELDS EYED AS BAROMETER FOR FED TAPER RISK, US DOLLAR DIRECTION

US Dollar Chart with Ten Year Treasury Yields Overlaid DXY Index Price Outlook

Chart by @RichDvorakFX created using TradingView

FOMC minutes noted, for example, how “a number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.” It is worth emphasizing that the latest batch of FOMC minutes are from the April 2021 Fed meeting, which preceded the release scorching red-hot CPI data and flash PMIs that highlighted an “unprecedented expansion” for economic activity across the US.

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