US Dollar (DXY): Higher after Cautious ECB Drives Euro Down

US Dollar (DXY) Highlights

• Fed raised interest rate, but no future hikes planned
• Market is still pricing in rate cuts despite Fed’s prediction
• ECB cautious with smallest hike since last summer

US Dollar (DXY) Overview

The US Dollar is edging higher against a basket of major currencies on Thursday after recovering from an early session setback.

The dollar was pressured after the Federal Reserve hinted at pausing its aggressive tightening cycle. However, it erased those earlier losses after the European Central Bank eased the pace of its rate hikes on Thursday.

At 14:04 GMT, June US Dollar Index futures are trading $101.150, up $0.035 or +0.03%. The Invesco DB US Dollar Index Bullish Fund ETF (UUP) is at $27.70, up $0.03 or +0.11%.

Fed Raises Rates, but Unsure about Future

On Wednesday, the Fed increased its benchmark overnight interest rate by 0.25%, which was expected. However, they removed language from their policy statement that suggested further rate increases would be necessary.

This has led analysts to wonder how long rates will remain at their current levels. While the Fed has indicated that rate cuts are unlikely this year, the market is still pricing them in. If the Fed’s predictions for 2023 are correct, it will be more difficult for the US dollar to decline later in the year.

For now, the market is focused on the idea that the peak in Fed rates justifies a peak in the US dollar and a reduction in the currency’s overvaluation. Money markets currently suggest a small chance of rate cuts beginning in June, with around 80 basis points of rate cuts expected through the end of the year.

ECB Hikes Rates, but Leaves Options Open

On Thursday, the ECB increased its three policy rates by 25 basis points, the smallest hike since it began raising rates last summer. The central bank did not commit to any further hikes and left its options open for future moves as it continues to combat high inflation in the euro zone.

The ECB’s tone was relatively cautious and focused on the past effects of tightening and its impact on the euro area economy. This balanced tone caused the euro to depreciate and lowered pricing for future interest rate hikes.

This reversed some of the gains the euro had made on Wednesday after the Fed’s rate hike announcement. The narrowing rate differentials between the US and Europe have been boosting European currencies, as markets are pricing in more European rate increases than in the US.

US Rate Hike Cycle Uncertain as Market Prices Cuts

If the current U.S. rate hike does end up being the last of its cycle, the big question for the FX markets will be how long rates will stay at these levels.

Despite the Fed’s indication that rate cuts are unlikely this year, the market is still pricing them in. If the Fed’s predictions for 2023 prove correct, it will be difficult for the USD to decline later in the year.

Currently, the market is focused on the idea that the peak in Fed rates justifies a peak in the USD and a reduction in its overvaluation. Money markets are pricing in a 15% chance of rate cuts beginning in June and expect a total of 80 basis points of rate cuts by year-end.

Technical Analysis

The main trend is down. It turned down earlier in the session when sellers took out $100.740. However, the market has rebounded from this low. June U.S. Dollar Index futures are currently straddling support (S1) at $101.094. Buyers came in as the index approached support at $100.420 and $100.345.

A sustained trade over (S1) will indicate the buying pressure is getting stronger with $101.303 (R1) and $101.463 (R2) the next targets. We could see an acceleration to the upside since the move will be fueled by a combination of short-covering and aggressive speculating.

A late session failure at $101.094 will signal the return of sellers. This could trigger a retest of $100.520 into the close.