I'm not a fan of the Dollar Index as a technical indicator but I think it paints the right fundamental picture at the moment. The dollar retraced modestly after a big runup to relieve some overbought conditions and now it's ready to challenge the July highs.
Will it breakout?
The Fed
The catalyst for today's rally is the Fed and the hawkish comments from Powell. Is that a platform for more dollar gains?
The answer is 'yes' but only if you think the Fed will follow through. Market pricing hasn't changed that much for Fed hikes today. So while Powell delivered a 'forceful' hawkish message, there are questions on whether he can deliver.
It will depend on the US economy and today's economic data wasn't bullish for the dollar. US PCE inflation was lower than expected and consumer spending was light. Had we seen this kind of breakout on high inflation and/or another strong non-farm payrolls report, I'd be more convinced.
The field
Perhaps a better case for the dollar is relative performance. The US might not be sizzling and the Fed might not continue with 75 bps hikes but it's certainly more than you will get elsewhere. Europe is in a full-scale energy crisis with a recession right around the corner. Japan is losing its status as the safe-have currency of choice and commodity-importing emerging markets are in trouble, creating direct flows into dollars. That's a nice mix and it's what's fueled the dollar rally all year long. Oftentimes, that kind of structural rally doesn't just fizzle, it leads to a spike.
The backdrop
The dollar retracement in the past five weeks was partly inspired by the Fed but also came with the risk picture improving. Now that the dollar is the safe haven of choice, it can rally if we see a further deterioration in stocks. The 3.8% decline in the Nasdaq today is a strong signal that we're not at the bottom of the bear market yet. If this mood continues for another few weeks, the dollar breakout could have legs.
