Has the dollar finally topped?

The US Dollar has had a very busy year. Following an 11% rally off the initial lows in January, which saw the Dollar Index breaking out to multi-year highs, we then saw an almost 4% correction before the greenback found fresh demand and rallied a further 4.5% taking the Dollar Index up to further, fresh, multi-year highs.

Price has since softened a little and the Dollar index is sitting just off these highs as of writing. Naturally, the more two-way action we’ve seen in the Index recently has got traders questioning whether the Dollar is topping out?

Key Factors driving the USD Rally This Year

  • Fed hawkishness and market expectations 
  • Multi-decade high inflation
  • USD safe-haven trade 
  • Divergence with other central banks 


The biggest driver behind the rally in USD this year was the steady increase in Fed hawkishness over late Q1 and Q2 and the subsequent uptick in the market’s expectations with regards to Fed tightening. Following the Fed’s 0.25% hike in March, its outlook and commentary turned increasingly hawkish leading to a larger 0.5% hike in May. With Fed commentary regarding inflation and the need for faster tightening hitting the wires regularly, market expectations drove USD firmly higher. 

Ahead of the June meeting, however, we saw a shift in narrative which largely fuelled the last big correction we saw. Speculation regarding a possible pause in rate hikes after the July meeting began to dominate the discussion. A modest drop in core inflation over April was accompanied by some Fed members opining that inflation was now moderating and that following the well-signalled June and July .5% hikes, the Fed would look to pause on rate hikes to assess the impact on the economy. 

However, a subsequent jump in inflation over May firmly squashed this view and the Fed was seen hiking by a larger-than-expected 0.75% in June along while upgrading its rates outlook for the remainder of the year. There is now chatter of a further 0.75% hike in July, possible even a full percentage point. 

Along with the rise in USD, driven by Fed hawkishness and market expectations with regard to the Fed and the Dollar, USD has also benefitted from safe-haven inflows. US stocks have plunged this year with the S&P alone down around 25% from yearly highs. The rising wave of central bank tightening around the globe, as well as the ongoing surge in inflation has raised growth concerns over the remainder of the year. This has fuelled a retreat into the USD as a safe-haven currency, particularly with the Fed raising rates so aggressively. 

The actions and outlook from the Fed have benefitted the Dollar particularly over recent months due in part to the actions and outlook from other central banks. With the BOE raising rates cautiously, trailing well behind the Fed, the ECB having only very recently shifted from its commitment to maintaining easing to signalling an upcoming July rate hike and with the BOJ reaffirming its commitment to stimulus, the divergence between the Fed and other central banks has benefited USD nicely. 

Recent price action in USD, however, suggests there has been a slight shift in the view about how long this divergence can last. So, what factors are causing this shift and are they likely to grow in prominence. 

Divergence with other central banks 

The first major factor to point out is the shift in the narrative at the ECB. Given the Euro’s importance within the Dollar basket and in terms of transatlantic trade, the ECB’s sudden and sharp hawkish shift has created an immediate drag on the USD. With the ECB signalling a 0.25% hike in July and a further 0.5% hike in September, this creates a huge shift in balance. Furthermore, this week we’ve heard from ECB’s Lagarde that upside risks are building and the ECB stands ready to front-load hikes (larger hikes in July and September) if necessary. 

Additionally, the BOE which had previously signalled a willingness to cool off on hikes has been forced to hike again due to inflation continuing to rise as well as signalling faster hiking to come in August, adding to the erosion of divergence between the Fed and other central banks. Not to mention, the RBA, RBNZ and BOC have each been raising aggressively and signalled their intention to continue. Even the SNB this month announced an unexpected 0.5% rate hike. 


The other major factor which has been drawing a lot of attention recently is the prospect of a recession in the US and globally. The combination of soaring inflation and higher borrowing costs has seen central banks around the globe, including the Fed, slashing growth forecasts across the remainder of the year. With US economic activity expected to falter there is a high risk that traders begin to rotate capital out of USD and into funding currencies such as EUR, CHF, creating further strength there, weighing on USD. 

The Dollar was seen losing steam last week as Fed’s Powell warned over likely recession risks as a result of tightening, shifting from his prior stance of optimism regarding the prospect of a soft landing. In light of this, and with the Fed keen to push ahead with further tightening in the meantime, there is scope for the dollar to pull back as growth fears dominate inflation fears, or perhaps the two combine ie stagflation. 

DXY – Weekly chart 


The Dollar index recently found support at a retest of the 2017 highs around 103.80. While above here, the outlook remains bullish with traders looking for a continuation above the current 105.70 highs. Above there, we might see a further push higher towards the 109.18 level. However, traders should be wary of a downside break of 103.80 at any point, which will likely signal a deeper reversal lower.