USD Wobbles but Outlook Brightens, EUR/USD & USD/JPY Embark on Divergent Trends

US DOLLAR ANALYSIS

The U.S. dollar, as measured by the DXY index, was modestly lower on Wednesday, down about 0.05% to 104.06, despite rising U.S. Treasury yields. Bond rates moved sharply higher across the curve for most of the trading session, especially those at the front-end after Bank of Canada came off the sidelines and surprised investors with an unexpected hike.

The U.S. and Canadian economies share strong parallels in terms of demand resilience and inflation stickiness, so monetary policy could follow a similar path in both countries. This means that if the Fed decides to hold rates steady in June, the pause could be short-lived, with policymakers resuming tightening shortly thereafter, and as soon as July.

If the Fed’s peak rate drifts higher than currently priced in, the U.S. dollar will be well-placed to regain leadership in the FX space. For this reason, it is imperative to keep an eye on incoming data such as the May CPI and PPI report. They could provide clues about the trend in overall prices and whether further tightening will be warranted in the future.

The chart below shows how implied yields on 2023 Fund futures have been rising in recent weeks amid a hawkish repricing of the monetary policy outlook. All things being equal, an acceleration of this trend should be bullish for the U.S. dollar.

2023 FED FUNDS FUTURES (IMPLIED YIELDS) VS US DOLLAR INDEX (DXY)

Source: TradingView

USD/JPY TECHNICAL ANALYSIS

USD/JPY lost bullish impetus in recent days after its strong rally in late May, but may soon regain positive momentum on widening yield spreads between U.S. and Japanese bonds (see chart below). This means the pair’s path of least resistance continues to be higher in the near term.

In terms of possible scenarios, if USD/JPY accelerates higher in the coming days, overhead resistance is located 140.45/144.90. If bulls manage to clear this barrier decisively, we could see a move toward 142.45, the 61.8% Fibonacci retracement of the October 2022/January 2023 pullback.

In the event of a setback, initial support appears around the 138.00 handle, followed by the 200-day simple moving average near 137.30. If both of these technical floors give way, sellers may become emboldened to launch an attack on short-term trendline support at 136.20.

USD/JPY TECHNICAL CHART

USD/JPY Chart Prepared Using TradingView

EUR/USD TECHNICAL ANALYSIS

EUR/USD broke below an important trendline last week in the wake of last month’s downward correction, but appears to be stabilizing now, with prices trapped between resistance at 1.0750 and support at 1.0640 at the time of writing.

While EUR/USD’s prospects have become less benign, the pair may regain poise if bulls manage to boost the exchange rate above technical resistance at 1.0750. If this constructive scenario plays out, upside pressure could gather pace, setting the stage for a move toward the psychological 1.0900 level.

In contrast, if bears retake control of the market and take out support at 1.0640/1.0600, all bets are off. This breakdown could weigh on sentiment, creating the right conditions for a retest of the 1.0500 handle, where the 200-day SMA aligns with the 38.2% Fib retracement of the Sept 2022/May 2023 rally.

EUR/USD TECHNICAL CHART

EUR/USD Chart Prepared Using TradingView