US dollar index (DXY) forecast ahead of PCE inflation report

The US dollar index (DXY) retreated slightly after the latest US GDP data and European Central Bank (ECB) decision. The index, which weighs the performance of the greenback against a basket of currencies, retreated to $103.20, down from this week’s high of $103.8. 

Hopes of a Fed cut fades

The US dollar index reacted mildly to the strong US GDP numbers. According to the statistics department, the economy expanded by 3.3% in Q4 after expanding by 4.9% in the third quarter. This growth was much better than the median estimate of 2.0%.

This report adds to the view that the American economy is, indeed, doing well even as challenges remain. Inflation has dropped from the pandemic-high of 9.1% to 3.4% while the unemployment rate remains at 3.7%. 

Additionally, there are signs that the manufacturing and services sector are doing well. According to S&P Global, the manufacturing PMI rose to 50.9 in January while the services one remained above 51. A PMI figure of 50 and above is a sign that a sector is growing. 

Further, consumer confidence has continued rising, which is a positive sign since their spending is the biggest part of the economy. Therefore, analysts have resigned to the fact that the Fed will not cut rates in its January and March meetings. Instead, most of them see it cutting rates in its June meeting.

ECB decision

The US dollar index also reacted mildly to the latest ECB interest rate decision. In it, the bank decided to leave interest rates unchanged as most analysts were expecting. The bank noted that inflation in the bloc was dropping although energy wa a major headwind. 

In addition to its rate decision, the bank also continued with its quantitative tightening (QT) policy. It intends to reduce its pandemic emergency purchase program funds by 7.5 billion euros in the first half of the year.

Economists expect that the ECB will maintain rates intact in the first half of the year and then deliver 2 or 3 cuts later. 

The ECB decision is important for the US dollar index because the euro is the biggest part of the dollar index. It constitutes about 57% of the total index.

US dollar index forecast

DXY chart by TradingView

The DXY index bounced back from the year-to-date low of $100.63 to a high of $103.81. Most recently, the uptrend has faded even after the strong US economic numbers. It has remained slightly above the 50-period moving average and formed an inverted head and shoulders pattern.

Therefore, the outlook for the index is neutral ahead of Friday’s PCE report. This is an important number because it is Fed’s favourite inflation report. It will be followed by next week’s Federal Reserve decision. The key DXY index levels to watch will be at $102.80 and $103.81.