US dollar threatens bullish revival as economic resilience returns: EUR/USD, USD/JPY, AUD/USD setups

• US financial conditions have loosened dramatically as traders rushed to price in large-scale Fedd rate cut wagers
• US economic growth remains resilient with data starting to impress again
• If these trends continue, markets may need to pare rate cut expectations
• US short-dated Treasury futures sit at key level, DXY breaks out
• US nonfarm payrolls on Friday key event for traders this week

Overview 

The dramatic loosening in financial conditions in the United States may already be starting to bear fruit for the economy, begging the question whether the Fed needs to slash interest rates below 3% as futures markets suggest.

If the dovish outlook is to experience another hawkish recalibration as witnessed earlier this year, it also raises questions as to whether recent weakening in the US dollar is justified? If rate cut bets are slashed, it’s likely the greenback will restrengthen again, creating downside risks for currencies such as the euro, Japanese yen and Australian dollar.

US data is picking up steam again

Have markets made the same mistake they did in late 2023 and early 2024 again, pre-emptively pricing over 250 basis points of Fed rate cuts over the next 18 months as policymakers signalled the start of the next rate cutting cycle?

The chart below is Citibank’s economic surprise index, an aggregate measure of how economic data prints relative to economist forecasts. A score above 0 indicates more data is beating than not, with a reading below 0 the opposite. In the top pane in red is US economic data, with the eurozone in the bottom pane in blue.

Source: Refinitiv 

Notice something?

After a prolonged period of underperformance earlier this year, US economic data has suddenly started to impress again relative to forecasts, sending the index above 0 for the first time since early May. At the same time, the euro index remains deep in negative territory where it’s resided since late June. The divergence between the two regions is stark, hinting US economic exceptionalism may be reasserting itself again. 

US economy growing above trend?

The index is not the only indicator that casts doubt on the needs for large-scale and rapid rate cuts in the US with the Atlanta Fed GDPNow model pointing to economic growth of 2.5% in Q3 based on data received so far, well above the theoretical 1.8-2% range many economists believe is the level where unemployment and inflationary pressures will remain stable.

Source: Atlanta Fed

Economic data is surprising and economic growth, at least according to this relative reliable model, remains robust. Markets are catching on that the myopic focus on labour market indicator may not be the best strategy, potentially missing the broader signal through the noise. Yes, it’s still very important, but it is a lagging indicator to changes in the real economy.

Fed rate cut wagers starting to unwind 

While still aggressive relative to the current resilient picture, it comes as no surprise that traders are scaling back the degree of Fed rate cuts we’re likely to see, stripping around 10 and 25 basis points out respectively by the end of this year and next.

US 2Y note futures warn of growing upside risks for yields 

The move in Fed funds futures is also impacting moves in US Treasuries further out the curve with two-year note futures reversing lower to test uptrend support after delivering a key bearish reversal on Monday. As one of the most liquid futures contracts globally, not just in rates, it would be unwise to dismiss the signals from this market.

If we were to see this uptrend broken, it could see the contract move down to test 103*33, a level where the important 50-day moving average and horizontal support intersect. If that were to give way, we could really see an unwind, pushing shorter-dated yields noticeable higher. We’ll have to wait for the price signal, but given the momentum we’re starting to see, the probability of such a move is increasing.

Friday’s US payrolls report therefore looms large, providing the type of event that could easily reshape the rates narrative for broader financial markets.

DXY breaking out 

Ahead of that key risk event, the US dollar index is already breaking out, smashing through the downtrend dating back to July after doing away with minor horizontal resistance at 101.228.

If the DXY were able to break downtrend resistance around 101.70, the 50-day moving average is the last real topside level until 102.35 where former horizontal and uptrend intersect. After the breakout, a retest of the 50DMA looks increasingly likely.

EUR/USD looks vulnerable to deeper pullback

For the largest constituent in the DXY, the EUR, a resurgent dollar may deliver a significant retracement, especially given renewed signs of economic divergence.

The downside risk flagged for EUR/USD in an earlier note this week materialised over recent days, with the break of the rising wedge facilitating a move down to the intersection of the 50-day moving average and horizontal support around 1.1050.

With momentum indicators generating bearish signals, selling rallies and breaks remains the preferred strategy near-term. On the downside, 1.1002 is the first level of note, with the uptrend running from June and downtrend established in July 2023 the next after that.

USD/JPY bullish reversal gathers pace

USD/JPY is recovering lost ground as US rate cut bets are pared, provided an additional tailwind on Wednesday as new Japanese Prime Minister Ishiba suggested now was not the environment where the Bank of Japan should be contemplating raising interest rates again, delivering a huge bullish bar on the daily chart to break above the key 50-day moving average. Having done away with that level, it may now be difficult for the price to reverse back lower without another big increase in US rate cut bets.

Those considering longs could use the 50DMA for protection, using it as a location to place stops below. If the price manages to punch through resistance just above 147, it could facilitate a run towards 149.70 or higher. Momentum is with the bulls, favouring buying dips and breaks rather than selling rallies.

AUD/USD looking heavy 

While arguably not a vulnerable to a resurgent US dollar as long as sentiment towards the Chinese economy remains buoyant, AUD/USD is also feeling the impact of the reduction in Fed rate cut bets, easing lower after being rejected at long-running downtrend resistance earlier this week.

The long topside wicks and break of the uptrend dating back to early September warn of near-term downside risks, especially with momentum indicators such as RSI (14) and MACD either trending or threatening to turn lower.

On the downside, .6824 may be targeted with the intersection of former downtrend and horizontal resistance. If that were to go, we’re looking at a flush towards .6733 and the 50-day moving average.

-- Written by David Scutt

Follow David on Twitter @scutty