The Dollar is testing resistance again

The US dollar opened the week at 18-month highs and near the upper limit of last week’s trading range. The DXY remains closely correlated with oil prices and came under pressure at the start of the day, but soon resumed its upward trend. Markets are increasingly convinced that the deal with Russia to supply diesel to the global market will have a limited impact on Brent, whilst the escalation in the Middle East is keeping oil prices elevated.

Alongside Brent, Treasury bond yields are rising, as are the chances of the Fed continuing its cycle of monetary tightening, fuelling interest in the dollar. Experts at the Wall Street Journal expect yields to remain elevated, easing to 4.78% by the end of next year, compared with 5.3% at the end of last week. These securities will remain attractive for an extended period, thereby fuelling demand for the greenback. Interest may even intensify if traders believe the sell-off is over and yields are at their highest in more than 20 years. 

Equally important, the US economy can withstand high interest rates, unlike the European economy. The budget crisis in France and political uncertainty surrounding the elections are acting as headwinds for the economy. Investors are unsure how this might all end, with the most likely scenario being a clash between the government and parliament, followed by the Prime Minister’s resignation. For the first time in the history of the eurozone, French bond yields have risen above those of Italy, turning the France-Italy spread positive. Italy’s budget deficit is almost half that of France. Even more surprisingly, Giorgia Meloni’s government has set a record for the longest continuous tenure in office in the entire post-war period, ensuring a level of political stability that no one would have expected from it some four years ago. Throughout this period, the spread between French and Italian bond yields has narrowed, and there is as yet no sign that this trend has halted.

According to Deutsche Bank, investors are factoring the debt crisis into EURUSD quotes. Still, they are underestimating the impact of factors such as disappointment with AI, whether due to a failed IPO or from frustration over technology companies' inability to generate profits in line with their actual and promised expenditure. In other words, there is a risk of a stock market bubble bursting, which would cause risk appetite to deteriorate sharply, triggering a wave of demand for the dollar and short-term Treasuries as safe havens. 

In the short term, the US September inflation report could influence the greenback. Consumer price inflation is forecast to accelerate from 3.4% to 3.7% y/y. Significantly higher figures would trigger a reassessment of the likelihood of a Fed rate rise in October. That said, inflation has statistically come in below expectations more often than not in recent months. Should this pattern persist, it would give the FOMC the leeway to postpone a rate rise until December, allowing markets to maintain low volatility.