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  • The DXY has dropped below the 91.00 level on Monday, picking up where it left off from last Friday’s losses.
  • Risk-on market conditions/bets on reflation appear to be weighing on the US dollar.

The Dollar Index (DXY), a trade-weighted basket of major USD exchange rates (such as EUR/USD, GBP/USD, USD/JPY and more), has struggled to gain ground on the first trading day of the week and currently trades flat and has fallen back below the 91.00 level in recent trade. That means that the DXY is continuing where it left off last Friday, when it fell back from two-month highs above the 91.60 mark last Friday following a downbeat US non-farm payrolls report; at the time, market participants suggested that the disappointing data reinforced expectations for Fed policy to remain easy for the foreseeable future (a USD negative), whilst boosting the prospect for a big fiscal stimulus package from the US Congress (impact on USD unclear).

USD drops amid risk-on conditions

US bond yields have been moving higher on Monday and seemed to offer the buck some support in the early European session. The US 10-year bond yield at one point rallied above the 1.20% mark for the first time since last March and the 30-year moved above the 2.0% mark. However, this support does not seem to have lasted long, as real yields are virtually unmoved and the US yield curve actually hasn’t actually steepened at all on Monday (higher real yields and a steeper curve is more of a bullish signal that just higher nominal yields on their own).

Monday’s move higher in nominal yields, but not in real yields represents a rise in inflation expectations; 10-year break-evens rose above 2.20% for the first time since 2018. These bets on reflation can be seen across financial markets on Monday; global equities are higher, energy markets, industrial metals and precious metals are all seeing gains.

The market’s “risk-on” mood is weighing on the safe haven US dollar a touch, or at the very least cancelling out any positive impetus the currency might derive from higher yields/shorts being covered. The main focus of the market is still on US fiscal stimulus and investors continue to place their bets that 1) the stimulus will be big and 2) the stimulus will boost inflation. For reference, both the US House and Senate passed the necessary budget measures required to begin the budget reconciliation process, which is said to put the passage of the next stimulus bill on “fast track”.

At the moment, “stimulus optimism” appears to be hurting the US dollar. However, if stimulus optimism translates into expectations of more than just higher inflation but tightening from the Fed as well, this will support the US dollar. In the meantime, there is always also scope for more USD short-covering to offer the buck some support; the latest number from CFTC suggests that speculative short positioning against USD only fell mildly in the week ending on last Tuesday.

This week

Looking ahead, USD is likely to trade somewhat cautiously ahead of key events later in the week; Wednesday sees the release of January Consumer Price Inflation (CPI) numbers out of the US followed by a speech from Fed Chair Jerome Powell. Amid all the attention on rising inflation expectations, the CPI numbers will be closely watched. Meanwhile, amid a hot debate amongst high profile past and present economic advisors to the ruling Democrat Party over whether US President Joe Biden’s $1.9T stimulus package would lead to the economy “overheating”, Powell’s remarks will be closely eyed.