US dollar index (DXY) nears a pivotal level ahead of NFP jobs data

The US dollar index has come under pressure in the past few days as investors focus on the recent US economic data and actions by the Federal Reserve and other global central bank decisions. It was trading at $104.17 on Thursday, down from the July high of $106.2.

Federal Reserve interest rate decision

The DXY index sold off after the Federal Open Market Committee (FOMC) delivered its July dsecision. In it, the bank decided to leave interest rates unchanged between 5.25% and 5.50%, where they have remained in the last few months. 

The rate decision was in line with what analysts were expecting and what the Fed has been signaling for months.

Nonetheless, the Fed confirmed that it was starting to think about cutting interest rates as its focus on its dual-purpose continued.

The Fed has two main roles: ensuring that the unemployment rate and inflation numbers are stable. On inflation, the Fed has put in place a 2% target.

Recent economic numbers have shown that inflation was still strong in the US. Nonetheless, the figure has dropped for three straight months and analysts believe that the trend will continue in the coming months. 

The Fed has also hinted that it will be ready to start cutting interest rates even before inflation moves to the target of 2.0%.

US nonfarm payrolls data ahead

Instead, the Fed has hinted that it was now more focused on the labor market, which has shown signs of weakness.

On Tuesday, a report by the Bureau of Labor Statistics (BLS) showed that the labor market was softening as the number of vacancies dipped to 2021 lows. 

Another report by ADP revealed that the private sector created just 122,000 jobs in July, its lowest number since 2023. 

The focus now shifts to Friday’s nonfarm payrolls (NFP). Economists polled by Reuters expect the data to show that the economy added 177,000 jobs in July after creating over 200k jobs in June. Like in the last few meetings, the BLS could downgrade its last NFP data. 

Meanwhile, analysts expect the unemployment rate remained at 4.1%, the highest level since 2021. Another report is expected to reveal that the average hourly earnings grew by 0.3% MoM and then softened from 3.9% to 3.8% in July. 

If these numbers are accurate, it means that the Federal Reserve will want to cut interest rates in its September meeting. In his statement on Wednesday, Jerome Powell noted that the bank left the door open for a rate cut during that month.

The Fed will receive several important economic numbers before the next meeting. It will receive the upcoming US Consumer Price Index (CPI) and Personal Consumption Expenditure (PCE) report this month.

Jerome Powell will then provide a hint of a rate cut at the Jackson Hole Symposium in August. In a note, Bob Michele, an analyst at JPMorgan said:

Unwinding of the carry trade

The US dollar index will also be under pressure as investors start unwinding the carry trade that has existed in the past few years.

A carry trade is a situation where investors borrow from low-interest-rate assets to higher-yielding ones. In the past few years, many investors have borrowed from places like Europe and Japan to invest in US assets. 

The most important carry trade unwind is happening in the USD/JPY exchange rate, which has dropped sharply in the past few days. This drop accelerated after the Bank of Japan delivered its second-interest rate hike of the year.

In Canada, the Bank of Canada (BoC) has continued implementing interest rate cuts as the economic slowdown continues. The same happened in Europe, where the European Central Bank slashed rates in the last meeting. 

The Bank of England is expected to start cutting interest rates on Thursday. While the cut will broaden the spread between US and UK yields, the impact will be limited if the Fed signals that it will cut rates in September.

Historically, the actions of the Federal Reserve tend to have supersized impacts on other currencies. 

US dollar index forecast

DXY chart by TradingView

Looking at the daily chart, we see that the DXY index formed a double-top pattern at $106.11. In price action analysis, this pattern is one of the most popular bearish signs in the market. It was now trading at its neckline.

Most importantly, the US dollar index has also formed a symmetrical triangle pattern shown in black. This triangle is nearing its confluence level, meaning that we could see it have major moves ahead. If this happens, the US dollar index will likely have a bearish breakout, with the next point to watch being at $103.