US Dollar extends rally as markets turn cautious on debt ceiling concerns

• US Dollar continues to gather strength following Thursday's decisive rebound.
• US Dollar Index climbed to fresh one-month high above 102.50 on Friday. 
• US banking woes and debt ceiling headlines could continue to drive US Dollar's valuation.

The US Dollar benefited from souring risk mood on Thursday and registered strong gains against its major rivals. As risk safe-haven flows continue to dominate the action on Friday, the US Dollar Index (DXY) builds on its weekly gains and trades at its highest level in a month over 102.50. 

Although there will not be any high-tier macroeconomic data releases from the United States ahead of the weekend, market participants will keep a close eye on headlines surrounding the banking crisis and the debt ceiling. Nevertheless, the US Dollar remains on track to register its best weekly performance since mid-March.

Daily digest market movers: US Dollar gains altitude into the weekend

• Consumer sentiment in the US deteriorated in early May with the University of Michigan's (UoM) Consumer Confidence Index falling to 57.7 (preliminary) from 63.5 in April. This reading came in below the market expectation of 63.
• The Congressional Budget Office (CBO) projects that if the debt limit remains unchanged, “there is a significant risk that at some point in the first two weeks of June, the government will no longer be able to pay all of its obligations”
• Beth Hammack, Chair of the Treasury Borrowing Advisory Committee and Co-Head of Goldman's Global Financing Group, said recently that a political deadlock over the US debt ceiling poses a "real risk" for the USD.
• President Joe Biden and top Republican lawmakers have postponed the next round of negotiations on debt limit to next week.
• Securities filing submitted by PacWest revealed on Thursday that the bank's deposits dropped nearly 10% last week. As the bank's shares lost more than 20% following this development, the financial heavy Dow Jones Industrial Average lost nearly 0.7% on the day.
• Commenting on the Federal Reserve's (Fed) policy outlook, "inflation is coming down, but so far it's been pretty darn persistent, that means we are going to have to keep at it for an extended period of time," said Minneapolis Federal Reserve President Neel Kashkari. 
• US Treasury Secretary Janet Yellen warned on Thursday that a US default on a failure to raise the debt ceiling would produce an "economic and financial catastrophe." On Friday, Yellen reassured that she is working full-time with Congress to raise debt ceiling.
• Fed Governor Christopher Waller said that they are worried about things like bank deposit runs, not climate change, when it comes to financial stability.
• The Core CPI inflation, which excludes volatile food and energy prices, edged lower to 5.5% in April from 5.6% in March as expected. On a monthly basis, the CPI and the Core CPI rose 0.4%, matching analysts' estimates.
• The BLS reported on Thursday that the Producer Price Index (PPI) for final demand in the US rose 2.3% on a yearly basis in April, down from the 2.7% increase recorded in March.
• The weekly data published by the US Department of Labor showed that Initial Jobless Claims totaled 264,000 in the week ending May 6. This print followed the previous week’s unrevised 242,000 and came in above the market expectation of 245,000.
• Commenting on the US inflation report, "the CPI report comes on top of the Nonfarm Payrolls (NFP) figures released less than a week ago, and together there is a compelling case for pausing," said FXStreet Analyst Yohay Elam. "Investors already see a growing chance of rate cuts, and that weighs on the Greenback." 
• The CME Group FedWatch Tool shows that markets are pricing in a more than 80% probability of the Fed leaving its policy rate unchanged at the next policy meeting.
• The benchmark 10-year US Treasury bond yield fell nearly 2% on Thursday before stabilizing near 3.4% early Friday.
• Earlier in the week, the Fed noted in its Loan Officer Survey for the first quarter that respondents reported tighter standards and weaker demand for commercial and industrial (C&I) loans to large and middle-market firms. "Banks reported tighter standards and weaker demand for all commercial real estate loan categories," the publication further read.
• On Monday, Federal Reserve Bank of New York President John Williams told the Economic Club of New York on Tuesday that the Fed needs to be data-dependent with monetary policy and reminded that the Fed will raise rates again if needed.

Technical analysis: US Dollar Index gathers bullish momentum

The US Dollar Index (DXY) climbed above the 50-day SMA for the first time since late March on Friday and the Relative Strength Index (RSI) indicator on the daily chart rose to 60, pointing to a buildup of bullish momentum. Buyers could look to retain control in case the DXY closes the week above 102.50.

On the upside, 103.00 (100-day SMA) aligns as the next bullish target ahead of 103.60 (static level from February) and 104.00 (psychological level, static level)

On the downside, 102.50 (50-day SMA) aligns as first support before 102.00 (psychological level, static level) and 101.65 (20-day SMA).

How does Fed’s policy impact US Dollar?

The US Federal Reserve (Fed) has two mandates: maximum employment and price stability. The Fed uses interest rates as the primary tool to reach its goals but has to find the right balance. If the Fed is concerned about inflation, it tightens its policy by raising the interest rate to increase the cost of borrowing and encourage saving. In that scenario, the US Dollar (USD) is likely to gain value due to decreasing money supply. On the other hand, the Fed could decide to loosen its policy via rate cuts if it’s concerned about a rising unemployment rate due to a slowdown in economic activity. Lower interest rates are likely to lead to a growth in investment and allow companies to hire more people. In that case, the USD is expected to lose value.

The Fed also uses quantitative tightening (QT) or quantitative easing (QE) to adjust the size of its balance sheet and steer the economy in the desired direction. QE refers to the Fed buying assets, such as government bonds, in the open market to spur growth and QT is exactly the opposite. QE is widely seen as a USD-negative central bank policy action and vice versa.