US Dollar Outlook Hinges on July Inflation Data after Gangbuster Jobs Report

US DOLLAR WEEKLY FORECAST: MIDLY BULLISH

  • The US dollar rallies before the weekend after US labor market data surprises to the upside, helping dispel recession fears
  • Strong job growth is and high wage pressures in the US economy are likely to prevent a monetary policy pivot by the Federal Reserve, creating a positive backdrop for the greenback
  • July US inflation data will steal the spotlight next week

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After a soft end in July, the US dollar, measured by the DXY index, rallied in the first week of August, up about 0.7% to 106.55, with most gains coming on Friday just before the weekend after US employment data surprised to the upsideremoving any hopes of a Fed pivot later this year.

For context, the US employers added 528,000 workers in Julymore than twice consensus estimates and the fastest pace of job growth since February, signaling that hiring remains strong and that recession fears may be overblown.

With the labor market still firing on all cylinders, no signs of widespread layoffs and wage pressures failing to moderate, the US central bank is likely to stay the course, raising borrowing costs forcefully in the coming months to cool demand and curb inflation. This situation may bolster US Treasury yields as investors price in a steeper hiking path and higher-for-longer interest rates.

In the current environment, the The US dollar may remain supported and even gain more ground against low-yielding currencies, such as the Japanese yen and euro in the near term. However, there is one variable to keep in mind that could potentially bring the greenback down: consumer price data.

We will get a better picture of the inflation profile next week when the US Bureau of Labor Statistics publishes the latest consumer price index results. According to a Bloomberg News survey, July CPI rose 0.3% mom, bringing the annual rate to 8.7% from 9.1% in June, a welcome directional improvement, but still an extremely high reading, more than four times above the central bank’s 2% target.

For markets to start discounting a less aggressive FOMC tightening cycle and lower terminal rate, inflation would need to come down meaningfully. This may not happen yet in the July report despite falling energy costs since late June. Against this backdrop, the fundamental forecast for the DXY index is mildly bullish for the week ahead.

US DOLLAR (DXY) DAILY CHART

usd chart

DXY Chart Prepared Using TradingView

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—Written by Diego Colman, Market Strategist for DailyFX

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