Q4 US Dollar Outlook: US Economic Exceptionalism to End?

US Dollar Takeaways

• The US dollar has surged on US economic exceptionalism so far this year, while economies in the Eurozone have underperformed.
• The Fed is either done or nearly done raising interest rates, but the full impact of rate hikes on the financial sector may still be coming in Q4.
• As long as the US Dollar Index remains above 105.90, the path of least resistance remains to the upside from a technical perspective.

US Dollar Fundamental Analysis

Heading into 2023, the big debate about the US economy was whether it would experience a “hard landing” (read: deep recession) or a “soft landing” (read: growth slowdown/mild recession) as a result of all monetary and fiscal tightening over the previous 18 months. Now, three quarters of the way through the year, the market has seemingly decided that the hard landing scenario is entirely off the table, and, based on strong US data of late, even the soft landing scenario may be too pessimistic.

We’re hesitant to wave the proverbial “all clear” flag for the US economy heading into the end of the year – monetary policy acts with “long and variable” lags after all, and there still is the potential for a government shutdown in November – but it’s clear that the US economy is outperforming its major rivals. As the chart below shows, composite PMI readings in the US have turned definitively higher, at the same time that readings on the European economy have rolled over:

Source:  TradingView, StoneX

Looking at monetary policy in more detail, the Federal Reserve has seemingly pushed back on fears of a sharp slowdown any time soon, leaving a potential interest rate hike on the table by the new year and removing two of its projected rate cuts from the 2024 “dot plot.”

While central bankers seemingly believe everything will be hunky dory (and are accordingly still engaging in quantitative tightening” to the tune of nearly $120B/mo), the key flashpoint to watch in the fourth quarter will be the financial sector. As the chart below shows, deposits are fleeing the banking sector at an unprecedented rate, and many small regional banks (remember those?) are facing large unrealized losses after the fastest interest rate rise in decades:

Source: Apollo

Ultimately, all modern capitalist economies run on debt and lending, so if we see another panic centered on the banks, it could pour cold water on the “US economic exceptionalism” theme…though as we saw in March, that doesn’t necessarily mean that the US dollar will fall!

Key developments to watch in Q4:

• We anticipate that the Fed will NOT hike interest rates again this year, but it’s certainly still possible if inflation or jobs data comes in elevated relative to expectations.
• Concerns over the health of the banking sector play a role in the above, with tighter credit taking a toll on growth more broadly.
• The economic exceptionalism of the US moderates as the US economy “catches down” to slowing growth in other regions

US Dollar Technical Analysis – DXY Weekly Chart

Source: TradingView, StoneX

Turning our attention to the weekly chart, the US Dollar Index (DXY) remains within a tight bullish channel as we go to press; indeed the market is in the midst of a 12-week winning streak, showing investors’ clear preference for the relatively strong growth and high yields offered by the US economy.

In terms of the levels to watch on the US Dollar Index, previous-resistance-turned-support at 105.90 could well put a floor under any near-term dips; a similar dynamic could emerge around 104.50 if that level gives way.

To the topside, there’s little in the way of nearby highs and lows, so traders will likely look to the Fibonacci retracements of the 2022-23 pullback, including 107.20 (50%), 109.00 (61.8%), or even 111.50 (78.6%) if the bulls are able to maintain the recent bullish momentum. As long prices can hold above the late-September breakout level at 105.90, the path of least resistance for the US Dollar Index will remain to the upside.

-- Written by Matt Weller, Global Head of Research

Follow Matt on Twitter: @MWellerFX