The U.S. dollar has been bouncing off a one-year low against a basket of currencies, following the release of data showing retail sales fell in March.

This is coupled with a warning from a key Federal Reserve official that interest rates need to continue to be raised to bring down inflation. While investors are anticipating a slowdown later in the year, the economy remains relatively strong.

Senior foreign exchange strategist at TD Securities in New York, Mazen Issa, said, “The overarching theme is you’re getting a slowdown… I think what gets overlooked is it may take longer for things to unfold, maybe a grind, and the U.S. economy is more resilient than people have given it credit for.”

The dollar initially fell, but then reversed and moved higher after U.S. retail sales fell more than anticipated, with consumers cutting back on purchases of motor vehicles and other big-ticket items.

Issa added, “It was generally on the weak side with the exception of the retail sales control group, which is super core retail sales, it was just a little less negative than expected and makes you think that maybe the market was looking for something much weaker.”

This data was released just before Federal Reserve Governor Christopher Waller warned that despite aggressive rate increases over the past year, the central bankers haven’t made much progress in returning inflation to their 2% target and that interest rates still need to be raised.

Atlanta Fed President Raphael Bostic also suggested that one more quarter-percentage-point interest rate hike could allow the Fed to end its tightening cycle with some confidence that inflation will return to its 2% target.

Currently, Fed funds futures traders are pricing in an 85% probability that the Fed will hike by an additional 25 basis points at its May 2-3 meeting.

The dollar has dropped due to cooling inflation, with consumer prices barely rising in March and producer prices unexpectedly falling in the same month. However, some of Friday’s rebound may be investors taking profits from trades betting on a dollar decline.

As of the end of Friday, the dollar index was up 0.26% on the day at 101.22, after earlier falling to 100.78, the lowest since last April. The euro fell 0.23% to $1.1025, while the dollar gained 0.35% against the yen to 133.05.

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.

The U.S. dollar had a remarkable week, seeing an increase of around 0.65% to reach 103.63 over the past five days of trading.

This rise allowed the greenback to fully recover from the losses it faced in January, Investors King research showed.

The boost was mainly driven by a significant rise in Treasury yields across the board, fueled by expectations that the Fed will have to keep raising borrowing costs to fight against inflation.

The 2-year and 10-year bond yields hit their highest point in four weeks, as traders adjusted their monetary policy expectations due to the revised terminal rate of 5.17%, which was previously 4.92%. This change was indicated by the 2023 Fed futures contracts.

Strong employment data has shifted the perspective on Wall Street, causing traders to reevaluate their predictions for Federal Open Market Committee (FOMC) hikes, due to the American economy’s remarkable resilience and ability to handle further tightening. The January jobs report showed that U.S. employers added 517,000 jobs, nearly double the expected amount, which could lead to upward pressure on wages and household spending.

The latest inflation report from the U.S. Bureau of Labor Statistics, set to be released on Tuesday, will give a clearer picture of consumer prices. Both headline and core Consumer Price Index (CPI) are expected to have risen by 0.4% on a seasonally adjusted basis, which would reduce the annual rate to 6.3% and 5.5% respectively.

However, this improvement could disappoint expectations due to a sudden surge in gasoline prices, which rose by 4.4% at the start of the year, according to the American Automobile Association. If the CPI does not meet expectations, traders may revise their predictions for the terminal rate, leading to higher yields and further strengthening the U.S. dollar in the coming weeks.

From a technical analysis perspective, the U.S. dollar index appears to be approaching a crucial resistance level near 103.80/104.00 after its recent rebound. If this level is breached, the bulls may push the dollar higher towards 104.65 and 105.60. On the other hand, if prices are rejected, initial support can be found around the 103.00 handle, created by a long-term rising trendline.