Fundamental Analysis: US CPI & Central Banks in Focus

The forex market is bracing for a potentially volatile week as we approach the end of 2024. The US dollar, after a brief stumble, has staged an impressive comeback, defying expectations and leaving traders questioning its next move. With crucial economic data releases and a flurry of central bank decisions on the horizon, the currency markets are poised for significant fluctuations.

US Dollar: A Resurgence Fueled by Economic Strength and Inflation Concerns

The US dollar index, a measure of the greenback’s value against a basket of major currencies, has surprised many by rebounding strongly after facing selling pressure earlier this month. This resilience comes despite a mixed bag of economic data, highlighting the complex forces at play in the currency market.

While recent labor market data has been generally positive, with healthy job openings and nonfarm payroll figures exceeding expectations, inflation remains a persistent concern. Average hourly earnings data released last week surpassed forecasts, signaling that inflationary pressures are not abating as quickly as some had hoped. This has fueled concerns that the Federal Reserve may need to maintain its hawkish stance for longer, potentially supporting further dollar strength.

All eyes are now fixed on this week’s US CPI inflation report. Economists project that inflation will remain “sticky,” with core CPI expected to rise 0.3% month-on-month and 2.7% year-on-year. However, given the continued strength of the US economy, resilient consumer spending, and potential seasonal factors related to the holiday season, a hotter-than-expected CPI print could further bolster the dollar and potentially trigger a reassessment of the Fed’s policy trajectory.

Technical Analysis Reinforces Dollar’s Bullish Outlook

The technical picture for the US dollar index also suggests further upside potential. The index has found solid support around the 105.50 level and has formed what could be interpreted as a double bottom pattern, a classic bullish signal. A decisive break above the recent highs could pave the way for a move towards the 108.00 resistance zone, last seen in November.

Moreover, the dollar’s strength is not just evident in the index. Several major currency pairs, including EUR/USD, AUD/USD, and USD/CAD, have shown signs of weakness against the greenback.

RBA to Stay the Course, But Aussie Dollar Faces Mounting Challenges

Across the Pacific, the Reserve Bank of Australia (RBA) is expected to maintain its cautious stance at its monetary policy meeting this week. While recent Australian economic data has shown some signs of cooling, with GDP growth slightly below expectations and inflation easing, RBA Governor Bullock has reiterated that inflation remains uncomfortably high and that further tightening may be required to bring it back to the target range.

This suggests that the RBA will likely keep interest rates unchanged for now, continuing its “higher for longer” strategy. However, the Australian dollar (AUD) faces a confluence of challenges, particularly against the resurgent US dollar.

The AUD/USD has broken below key support levels and formed a bearish pennant pattern, a technical formation that often precedes further declines. A break below the 0.6400 level could open the door for a move towards the 0.6300 support zone. Thursday’s Australian labor market data will be closely watched, as any signs of weakness could exacerbate the Aussie’s woes.

Eurozone Grapples with Economic Headwinds and ECB Rate Cut

The eurozone economy continues to face a challenging environment, with recent PMI data confirming ongoing contraction in major economies like Germany and France. Political instability in Germany, where Chancellor Scholz’s coalition government is facing internal strife, and difficulties in passing the budget in France add to the gloomy outlook. Against this backdrop, the European Central Bank (ECB) is widely expected to deliver a 25 basis point rate cut this week.

However, market participants will be paying close attention to ECB President Christine Lagarde’s tone and forward guidance. A dovish message, emphasizing downside risks to the eurozone economy and leaving the door open for further rate cuts, could weigh heavily on the euro. Concerns about fragmentation within the eurozone, with some member states facing higher borrowing costs than others, could also contribute to euro weakness.

The EUR/USD has been trading sideways lately, and a downside break could trigger a sharp decline towards parity. Traders will be closely monitoring the 1.0500 support level, a break of which could accelerate the euro’s descent.

Swiss Franc Awaits SNB Decision Amidst Diverging Expectations

The Swiss franc (CHF) faces uncertainty ahead of the Swiss National Bank (SNB) monetary policy meeting this week. Market expectations are divided, with some anticipating a 25 basis point rate cut, while others predict a more aggressive 50 basis point reduction. Inflation has been falling rapidly in Switzerland, but a modest 25 basis point cut may not be enough to significantly weaken the franc, especially given the safe-haven appeal of the currency.

The USD/CHF has been range-bound in recent weeks. A decisive break above the 87.50-88.00 resistance zone could signal further gains for the dollar, potentially targeting the 90.00 level. However, a surprise 50 basis point cut from the SNB could trigger a sharp reversal, sending the franc higher.

Bank of Canada Poised for Another Dovish Move

The Bank of Canada (BoC) has been one of the most dovish central banks among the G7 economies, and it is expected to deliver another 50 basis point rate cut this week. Cooling inflation, a weakening labor market, and slowing economic growth support the BoC’s continued easing bias. Moreover, recent data showing a contraction in the Canadian manufacturing sector has further reinforced the case for looser monetary policy.

The USD/CAD has recently broken out to the upside, and the path of least resistance appears to be higher. The 1.4350, 1.4600, and even 1.4800 levels are potential targets for the pair, with the possibility of challenging the highs seen in 2016 and 2020.

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