Impasse in debt ceiling negotiations

Last week’s optimism towards a debt ceiling deal faded overnight as another day of talks failed to deliver progress towards an agreement.

While US President Joe Biden and House Speaker McCarthy have projected optimism and agreed that default is not an option, the market is now at the point where it wants a little less conversation, a little more action.

Market reaction and dollar rise amid global economic concerns

Specifically, the continued impasse is now viewed as bad news and overnight generated a traditional risk-off response of lower equities and a higher US dollar. Although we hasten to add, it’s not just the debt ceiling debacle and risk aversion that is driving the US dollar higher.

The US dollar index (DXY) includes a 57% weighting of the euro. Earlier this month, the first cracks in the Euro Area growth story emerged as Euro Area industrial production fell by 4.1% m/m, the steepest drop since March 2020.

The cracks deepened overnight as the Euro Area Manufacturing PMI fell to 44.6 in May, which, apart from the Covid pandemic in early 2020, was the weakest since July 2012.

Impact of China's slowdown on the US dollar

The US dollar is also receiving support from China slow down concerns. USD/CNY closed yesterday at its highest level since December. The Chinese currency, the yuan, has now given back all its gains and more since the China re-opening in early December.

Should the slowdown in China and the Euro Area deepen, the anti-cyclical US dollar will continue to rise in the medium term.

Short-term prospects of US dollar: Focus on FOMC meeting

Looking ahead in the short term, aside from the impacts of the debt ceiling discussions, the US dollar's upward trajectory hinges on the forthcoming disclosure of the Federal Open Market Committee (FOMC) meeting minutes.

Market participants are keenly interested in understanding the specifics that could prompt a hold or even a further tightening in monetary policy. Equally important is the committee's perspective on the Senior Loan Officer Opinion Survey (SLOOS) data.

Another critical factor to consider is whether the Federal Reserve staff's expectation of a modest recession for this year is still valid.

DXY technical analysis

In 2023, the US dollar index, the DXY, tested and held support at 101.00/80 on three separate occasions, providing evidence of a base.

After an encouraging rally in May, the DXY is now eyeballing downtrend resistance at 104.00, coming from the September 114.78 high.

While it would be highly unusual to see a clean break of a significant technical level on the first attempt in these types of finicky markets, a sustained break of 104 would likely be the catalyst for the DXY to extend its rally towards significant resistance at 105.80/106.00 coming from the March 105.88 high and the 200-day moving average.

DXY daily chart