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US Dollar Pulls Back After a Monster 12 Months

  • US economic growth fears have cascaded to the dollar as the greenback has pulled back over the last two weeks

  • Disappointing corporate earnings and troubling economic data further lead traders to believe that a US recession may not be far off

  • There are important intermarket considerations should the USD pause after a huge run off its low a year ago, and some signs of a "blow-off top"...

Growth fears are becoming front and center after inflationary worries were top of mind earlier in 2022. A bearish regime change continues to unfold. We see this mindset shift across asset classes over the last month or two. US Treasury yields retreated sharply off the highs while the US dollar has pulled back off an incredible 17% advance from a year ago. Recession fears cascade across trading desks following some dismal earnings reports last week and concerning economic data this week.

A Blow-Off Top?

Zooming in on the greenback, going into Wednesday, the US Dollar Index (DXY) was off nearly 3% over the previous eight trading days - nearly the worse dollar drubbing since the Covid crash. That’s unmistakable evidence of traders’ questioning the strength of the US economy. The dollar had rallied sharply starting a year ago to coincide with incredible nominal and real domestic economic growth. A negative Q1 GDP print was largely dismissed since it was due to a reduction in net exports while consumer activity was still strong.

Micro Problems Underscore Macro Problems

Then came the awful profit results from retailers like Walmart and Target. While we don’t focus so much on the micro, those major chains’ warnings and poor execution indicate trouble at the macro level. The past few weeks have also included a pullback in expectations for both future inflation and how much the Fed will tighten. These are key clues that suggest a US recession is not far off; the US Dollar Index is responding accordingly. Our featured chart below illustrates a huge DXY move over the last 12 months.

Featured Chart: US Dollar Index Breaks Out, then Pulls Back

Dollar Details

Our weekly Global Cross Asset Market Monitor report, sent each Monday morning to clients, details what’s happening with the DXY. The common ETF to play the dollar is the Invesco DB US Dollar Index Bullish Fund (UUP). The Index spiked above 105 last week to cap off a stellar run from under 90 a year ago. It then dipped under 102 this week before bouncing back Wednesday. Our composite breadth indicator suggests a possible blow-off top in the USD.

Intermarket Relationships

The weekly report digs into previous instances of max-breadth turning into lackluster dollar performance thereafter. Macro traders know well that when the DXY reverses course, there are major ramifications to other asset classes. We have already seen relative strength from foreign stocks vs US shares as well as buying of Treasuries. Recall how the January through March period featured an interesting correlation between higher interest rates and a higher USD.

The Bottom Line: Traders should be on the lookout for possible moves lower in the DXY. That being said, the index rests at a critical support point. A deeper pullback could ease the pressure in some foreign markets, including EMFX. Expect continued volatility in the currency world as market participants grapple with looming global recession risks.

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