U.S. Dollar Retreats on Wall Street Positivity, but Hawkish Fed Could Spark Reversal

On Monday, the U.S. dollar weakened slightly, with the Dollar index down 0.25% to 104.24 as Treasury yields pulled back and Wall Street sentiment remained positive.

However, this retreat may be short-lived, as several factors on the economic calendar this week could trigger a bullish reversal in the foreign exchange (FX) space.

One key catalyst is the Federal Reserve’s semi-annual monetary policy report to Congress. Fed Chairman Jerome Powell is scheduled to speak on Tuesday and Wednesday, discussing recent economic developments and prospects for the future.

It is expected that Powell will take a hawkish stance, laying the groundwork for a higher peak rate in response to upside inflation risks.

While economic data from late 2022 suggested that price pressures were abating, recent reports have shown the opposite. Inflationary forces remain stubbornly strong, buoyed by resilient consumer spending and tight labor markets.

Several measures of price indices over different time horizons indicate that the central bank may not be able to achieve its 2% inflation target for the foreseeable future.

Powell’s testimony may open the door to bigger rate hikes, cementing calls for the Fed to raise borrowing costs by 50 basis points at its March meeting and pushing expectations for the terminal rate closer to 6.0%.

This scenario could be quite bullish for the U.S. dollar, signaling a shift in monetary policy that would likely support the currency.

Investors will be watching Powell’s remarks closely, as any indication of a more aggressive rate-hiking cycle could prompt a surge in demand for the U.S. dollar. While the current retreat may be a result of short-term market dynamics, the outlook for the currency could shift rapidly in response to the Fed’s policy decisions.