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US Dollar Weekly Forecast: Slightly Bearish

• The US dollar plummeted this week following weaker-than-expected US inflation data.
• Slowing price pressures may lead the Federal Reserve to adopt a less hawkish stance, prompting policymakers to slow the pace of interest rate hikes as soon as their next meeting.
• The downward correction in yields could push the dollar lower in the near-term.

The US dollar, as measured by the DXY index, plunged nearly 4% to its weakest reading in almost three months this week (~106.4) after the latest US inflation report surprised to the downside by a wide margin, prompting traders to reprice the path of monetary policy lower.

October headline CPI clocked in at 7.7% year-over-year versus 8.0% year-over-year expected, hitting its lowest level since January, which is a positive step in the fight to restore price stability. The core gauge also cooled, easing to 6.3% from 6.6% previously on the back of a steep decline in medical care costs.

The encouraging data strengthened the case for the Fed to downshift the pace of interest rate increases as soon as next month, with traders now assigning a more than 80% probability to a 50 basis point hike and almost ruling out a 75 basis point adjustment in December, as seen in the chart below.

Source: CME Group

In light of these developments, the FOMC terminal rate, implied by the Fed's 2023 futures, has drifted lower, causing a sharp pullback in US Treasury rates (see last chart). While one report does not change a trend and will not be enough to convince policymakers to alter course, it may put a ceiling on bond yields as traders attempt to front-run the central bank's next moves. The US dollar will struggle in this environment.

2023 Fed Funds Futures (Implied Yield)

Source: TradingView

Another factor that could weigh on the greenback in the near-term is improving sentiment, which has clearly been reflected in the strong and furious equity market rally seen over the past two sessions. If stocks continue to rip in the coming days, high-beta currencies could extend gains against the US dollar, paving the way for further declines in the DXY index.

Although traders who have taken bearish positions in the US dollar recently may be inclined to book profits, triggering a technical rebound, any bounce may prove transitory until Fedspeak or incoming macro data give way to a new narrative. Having said that, the near-term balance of risks appears tilted to the downside for the US dollar.

US Dollar (DXY) & Treasury Yields Daily Chart

DXY Chart Prepared Using TradingView

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