The greenback’s attempts to recover after July US CPI report proved to be unsuccessful in the second half of the week. After forming a weekly peak at 93.15 on Wednesday, DXY tumbled on the report. Following a failed attempt to gain a foothold on above 93 level Thursday, it resumed its slide on Friday as buying pressure eased on lack of short-term catalysts.
However, upside potential for DXY remains abundant in the second half of August thanks to upcoming Fed announcements and inflation developments. US macro data released on Thursday again drew attention to inflation risks. In particular, production prices rose in July at the fastest pace in more than a decade - 7.8% YoY. Of course, last year's low base made decent contribution to the growth but, what is important is that production prices during periods of economic recovery are the leading indicator of consumer inflation. Firms raise consumer prices in response to rising costs as they feel that their pricing power increases. This is especially true in the pickup phase of current economic cycle driven by stimulus-fueled consumer demand. Therefore, although the CPI for July hinted that annual inflation most likely passed its peak, it may take longer for it to return to a comfortable range for the Fed with an average of 2%. This increases the risk of proactive Fed approach. Markets also took the data on unemployment benefits with caution. Another low in continuing claims and improvements on the side of initial claims, which increases chances for strong August NFP report and more inflation thanks to strong wages.
The Fed is expected to announce a plan to taper bond purchases in September, with corresponding hints at the upcoming Jackson Hole conference in August. While the Fed Chair Jeremy Powell has stated on several occasions that the surge in inflation is temporary and does not require a policy response, other officials have expressed growing concern about rising prices and resilience of inflation. Overall suggesting it may be more reasonable to act sooner than later. Therefore, despite disappointment in inflation, the dollar is declining reluctantly as there is big news ahead.
From a technical point of view, the dollar index faces the dilemma of returning back into the medium-term wedge pattern or trying to stay above its upper bound after a breakout. The price has been forming this pattern for several months, and before the US CPI report this week, the upper border was broken:
If the price does not manage to gain a foothold above the resistance line, the dollar may come under more bearish pressure next week with the closest bears’ target at 92.50 level. However, betting on USD recovery ahead of Jackson Hole meeting makes sense as risks are skewed towards hawkish Fed shift which should support bond yields rally as well as USD demand.