Why the DXY break is different this time

The recent escalation in the trade war accompanied by a further deterioration in global growth has all but confirmed the Federal Reserve will cut rates by 25bps at its next meeting, Thursday, September 19 at 4.00am AEST.

The market is already 100% priced for this outcome and for another 25bp cut to be delivered by the Fed before year-end. Another 65bp of cuts are priced for 2020. The temptation for the Fed must be to follow the lead of the RBNZ and to deliver a 50bp cut before year-end, thereby front-loading its stimulus.

Despite the now higher probability that the Fed commenced an extended easing cycle rather than a “mid-cycle” adjustment on August 1, the U.S. dollar index (DXY) has continued to appreciate, resulting in a correlation breakdown between the DXY and interest rates.

As can be viewed in the chart below, the DXY and 10-year U.S. interest rates are usually positively correlated, which means they mostly travel in the same direction. In early 2018, there was a breakdown in this relationship as investors shunned the U.S. dollar after Trump's tax cuts sparked fears of the “twin deficits” (large government deficits occurring at the same time of trade deficits).

In mid-2019, the correlation has again broken down. Interest rates have moved significantly lower, while at the same time the U.S. dollar is trading at two-year highs. In short, ongoing demand for U.S. dollars from a variety of sources, including safe-haven demand, has outweighed the effect of lower interest rates. How long this breakdown can continue is unknown and one of the reasons why the technical picture below is important.

After a handful of failed attempts in recent months, the DXY has posted its second consecutive daily close above the top of trend channel resistance. As such, providing the DXY holds above the top of the trend channel in coming sessions, the DXY can now look towards the next upside targets at 100.50 and then 103.50.

On the downside, dips towards 98.80/60 are likely to be well supported with only a break and close below 98.30 suggesting the latest breakout attempt has failed.

Source Tradingview. The figures stated are as of the 3rd of September 2019. Past performance is not a reliable indicator of future performance.  This report does not contain and is not to be taken as containing any financial product advice or financial product recommendation

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