Dollar in Focus: Market Analysis and Outlook Following Central Bank Meetings

The Dollar Index on Monday is hovering near the neutral level of 102.50, indicating that the market has absorbed the major news from the past week. This, of course, refers to the parade of performances by major central banks – the Federal Reserve, the European Central Bank, and the Bank of England. The U.S. Federal Reserve left interest rates unchanged, increased the expected rate cuts in 2024 in the updated Dot Plot, and Fed Chair Powell even decided to adopt a much less uncertain (than usual) regulatory stance, stating that officials are indeed discussing rate cuts. It's worth noting that the meeting results sharply contrasted with market expectations.On the contrary, the ECB tried to convey to the markets that they are currently pricing in excess easing of monetary policy. According to Christine Lagarde, officials did not discuss the question of a rate cut. The market definitely did not expect such a position, so the Euro quickly strengthened. The European Currency Index (EXY) rose by 2% last Thursday and Friday, indicating that the weak dollar only partially contributed to the strengthening of the European currency.Changes in the U.S. yield curve since last Thursday demonstrate interesting dynamics. The FOMC meeting caused a decline in yields across all maturities, but then the two-year bond rate began to recover, while the yield on the 10-year bond continued to decline. The rise in short rates on Friday was boosted by positive reports: November retail sales data showed higher-than-expected growth, and unemployment benefit claims again fell to a cyclical minimum (202K versus a forecast of 220K). S&P Global's Services PMI also supported the expansion, increasing to 51.3 points compared to a forecast of 50.6.The divergent movement of market rates is essential to a forecast that long-term investments will yield higher inflation-adjusted returns than sequential investments in a series of shorter-term securities. The U.S. dollar is also more sensitive to fluctuations in long-term Treasury yields, so the dollar's decline was significant. Such divergence in short- and long-term rates often increases risk appetite and the search for yield, so investors in the U.S. stock market may now feel much more confident in chasing yield.However, some Fed officials are trying to temper the rapid development of market expectations for dovish Fed policy in 2024. For example, Loretta Mester stated last Friday that the market has somewhat "run ahead" with the story of aggressive rate cuts in 2024. New York Fed President Williams also spoke against such market expectations, stating an "overreaction" to the FOMC meeting. The president of the Atlanta Fed stated that he sees two rate cuts in 2024, not before the second half of the year. Such rhetoric creates the risk of some upward correction in long-term yields and, consequently, the strengthening of the dollar, but for this, the incoming data flow must convincingly indicate that the market is indeed right in its expectations.On Monday, the IFO report on business climate in Germany restrained the rise of the European currency, keeping EURUSD in a narrow intraday range of 1.09 – 1.095. Among the key events this week, the meeting of the Bank of Japan tomorrow, inflation data in the UK on Wednesday, and U.S. Core PCE on Thursday stand out.It's worth paying attention to the technical picture of the dollar index, where an interesting setup is forming. The price is in a descending channel, but in the second half of last week, there was a test of the support line, which previously acted as resistance in the bearish channel of the dollar. There are good chances for a slight pullback, but if realized, the buyers' target could be the upper boundary of the current descending trend, roughly corresponding to the 103-103.20 area.