US Dollar on the back foot with French political outcome applauded by markets
- The US Dollar has a volatile start of the week, though it is on the back foot early on Monday.
- Talk of the town is the surprise gain of the left coalition in France.
- The US Dollar index hovers around 105.00, testing a vital level of support.
The US Dollar (USD) whipsaws on Monday, with markets celebrating the outcome of the second round of elections in France. In a surprise move, the left-wing coalition New Popular Front of Jean-Luc Mélenchon won and claimed victory, while the current ruling French President Emmanuel Macron’s centrist Ensemble alliance came in second. This is a surprise blow to the far-right National Rally of Marine Le Pen, who had a landslide victory in the first election round last week. With no one holding an absolute majority and political agendas being very dispersed and barely having any common ground, a hung parliament or a minority government seems to be the only possible outcome for now. Still, the far-right movement appears to be halted.
On Monday, all eyes will be on the bond market and the spreads between France and Germany. On the US economic front, it is a very calm start to the week. US Federal Reserve (Fed) Chairman Jerome Powell is heading to Capitol Hill on Tuesday and Wednesday for its semi-annual testimony on the economic outlook and recent monetary policy actions before the Joint Economic Committee. That is just ahead of the US Consumer Price Index (CPI) data for June, which is scheduled for Thursday. y.
Daily digest market movers: Bond markets happy
- As mentioned above, a hung parliament looks likely in France, still the far-right movement appears to be halted. This translates into a drop in yield spreads between France and Germany. Last week, the spread between the two 10-year sovereign bond yields rose towards 81 basis points when Marine Le Pen’s far-right party was in the lead. The gap now narrows to 65 basis points, with, on average, the spread being around 50 basis points in normal conditions.
- Markets are applauding the stalemate situation because the far left party has no majority to pass its extensive and excessive spending agenda. Actually, not any party will be able to push through any sort of reform until the next elections, which will be the Presidential ones, on April 11, 2027.
- Over the weekend, more democratic key people in the US came out to ask President Joe Biden to resign and pave the way for someone else.
- At 15:30 GMT, the US Treasury Department will auction a 3-month and a 6-month bill.
- The US Consumer Credit Change for May is expected to rise to $8.65 billion from $6.4 billion.
- All major indices are marginally in the red, looking for direction from across Asia or Europe into US futures. This Monday could be a volatile, choppy ride.
- The CME Fedwatch Tool is broadly backing a rate cut in September despite recent comments from Fed officials. The odds now stand at 69% for a 25-basis-point cut. A rate pause stands at a 26.1% chance, while a 50-basis-point rate cut has a slim 4.8% possibility.
- The US 10-year benchmark rate trades at 4.29%, near its weekly low.
US Dollar Index Technical Analysis: Traders shun away
The US Dollar Index (DXY) fell out of bed on Monday in early trading, with markets scrambling to look for direction on the back of the French election outcome in the second round. Expect this news to get digested by the US markets as no changes are taking place in France on the international forum, with no additional spending packages or reforms to be pushed through with a non-majority government. All eyes will be on the bond markets because the declines in European yields are also spilling over into US bonds, where a further decline could drive the DXY lower.
On the upside, the 55-day Simple Moving Average (SMA) at 105.18 has now turned into resistance after an early test during the Asian session received a firm rejection and pushed the DXY further down again to test the 105.00 level. Should that 55-day SMA be reclaimed again, 105.53 and 105.89 are the next nearby pivotal levels. In case Fed Chairman Powell delivers some hawkish comments before Congress later this week or the US CPI print points to a pickup in inflation again, the red descending trend line in the chart around 106.23 and April’s peak at 106.52 could come into play.
On the downside, the risk of a nosedive move is increasing, with double support at 104.77, the confluence of the 100-day SMA and the green ascending trend line from December 2023. Should that double layer give way, the 200-day SMA at 104.43 is the gatekeeper that should catch the DXY and avoid further declines. Further down, the correction could head to 104.00 as an initial stage.
US Dollar Index: Daily Chart
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.
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