US Dollar Index Hits Six-Week High as Fed Minutes Signal Inflation Concerns

The US Dollar Index (DXY), which measures the greenback’s strength against a basket of six major currencies, rose to a six-week high of 103.50 on Wednesday, as the minutes of the Federal Reserve’s latest policy meeting revealed that most policymakers were worried about the persistent inflation pressures in the US economy.

The DXY has gained more than 2% since the start of August, as the Fed’s hawkish stance and the global economic uncertainties boosted the demand for the safe-haven currency.

US Dollar Index Hits Six-Week High as Fed Minutes Signal Inflation Concerns
US Dollar Index Hits Six-Week High as Fed Minutes Signal Inflation Concerns

Fed Minutes Show Divisions on Tapering and Rate Hikes

The minutes of the Fed’s July 25-26 meeting, released on Wednesday, showed that the central bank was divided on when and how to start reducing its massive bond-buying program, which has been supporting the economic recovery from the pandemic. Some policymakers argued that the Fed should announce a tapering plan in September and start reducing its purchases in October, while others preferred to wait for more data on the labor market and inflation before making a decision.

The minutes also indicated that most Fed officials agreed that inflation was likely to remain elevated in the near term, and that they should be prepared to adjust their monetary policy stance if needed to prevent inflation expectations from rising too much. Some policymakers even suggested that the Fed should raise its benchmark interest rate sooner than projected, if inflation continued to run above its 2% target.

The Fed’s minutes contrasted with the dovish tone of Fed Chair Jerome Powell, who said in a speech last week that the central bank was still a ways away from considering raising interest rates, and that inflation was likely to moderate as supply bottlenecks eased. Powell also reiterated that the Fed would provide ample notice before tapering its bond purchases, and that tapering did not imply an imminent rate hike.

US Data Supports Hawkish Fed Outlook

The Fed’s minutes were supported by some upbeat US economic data released on Wednesday, which showed that the US industrial production rose by a stronger-than-expected 1% in July, while the capacity utilization rate increased to 79.3%, the highest level since February 2020. The data suggested that the US manufacturing sector was resilient despite the challenges posed by the Delta variant of the coronavirus and the global supply chain disruptions.

Moreover, the US housing market also showed signs of strength, as the building permits and housing starts both beat market expectations in July, indicating a robust demand for new homes. The building permits rose by 0.6% to an annualized rate of 1.442 million units, while the housing starts jumped by 3.9% to an annualized rate of 1.452 million units.

On Tuesday, the US retail sales also surprised to the upside, rising by 0.7% in July, despite a decline in auto sales. The data showed that consumer spending remained solid in the US, supported by higher wages and savings.

Global Risks Favor US Dollar Strength

The US dollar also benefited from its safe-haven appeal, as global risks weighed on investor sentiment. The ongoing turmoil in Afghanistan, where the Taliban seized control of Kabul after a swift military campaign, raised concerns about regional stability and security. The situation also sparked criticism of the US withdrawal strategy and its implications for its allies and credibility.

Meanwhile, China’s economic slowdown and regulatory crackdown also dampened the outlook for global growth and trade. China’s industrial production and retail sales both missed market forecasts in July, showing that the world’s second-largest economy was losing momentum amid rising Covid-19 cases and tighter restrictions. China’s authorities also continued to tighten their grip on various sectors, such as technology, education, gaming, and property, triggering fears of more policy uncertainty and market volatility.

Furthermore, the spread of the Delta variant of the coronavirus also posed a threat to the global recovery, as several countries faced rising infections and hospitalizations, forcing them to reimpose some lockdown measures or delay their reopening plans. The Delta variant also raised doubts about the effectiveness of vaccines and the prospects of achieving herd immunity.

Technical Analysis: DXY Faces Resistance at 103.50

The DXY has been in an uptrend since early August, breaking above several resistance levels along the way. The index is currently trading around 103.50, which is a key psychological level and also coincides with a horizontal resistance line drawn from the highs of June 2022. If the DXY can sustain above this level, it could target the next resistance at 104.00, which is another round number and also nears a descending trend line drawn from the highs of March 2020.

However, if the DXY fails to break above 103.50, it could face some profit-taking or correction pressure, as it is also trading near overbought levels on some technical indicators, such as the Relative Strength Index (RSI) and the Stochastic Oscillator. The index could then retrace towards some support levels at 103.00, 102.50, or 102.00, which are previous resistance-turned-support levels and also round numbers.

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