USD: What does an inverted V-shaped reversal signal indicate?

Morning FX

An extraordinary phenomenon occurred after Wednesday's CPI release: the US Dollar Index initially surged nearly 100 points, charging straight to the 103 level, then completely reversed course, giving back all its gains during yesterday's Asian opening. This dramatic inverted V-shape movement directly overshadowed the Dollar Index after last night’s PPI and retail data were released. Despite both figures vastly exceeding expectations, the Dollar Index seemed glued to 102, showing no reaction.

Why isn’t the US Dollar Index following the data?

(1) The stock market plunge is the primary concern

Following the September rate hike, the sustained rise of the Dollar Index relied heavily on the quiet support of a resilient US stock market. However, the unexpectedly high CPI figure immediately triggered a slump in US equities, reigniting the long-absent “rate hikes - stock market decline - fed put bailout - impeded rate hikes” pricing spiral in the market.

(2) The Federal Reserve is a direct driver

After the CPI release, three officials gave remarks. Except for Barkin, who remained vague and insisted on seeing the PPI before making the next decision, both Daly and Goolsbee bluntly stated, “CPI is high, but there’s no rush to hike rates.”

From a strictly independent central banking perspective, with solid employment and runaway inflation, trying to alleviate equity market panic is understandable—but come October, if a hike is due, it should happen. Yet now, another major pressure point is the midterm elections and fiscal strain on the Republican side. If Waller’s speech today is also attempting to dampen October rate hike expectations, one might speculate boldly that the Federal Reserve may intend to hold steady until the midterms conclude, pausing monetary policy to make way for fiscal considerations.

(3) Market positioning is the ultimate variable

Since the French fiscal crisis, long-dollar positions have surged sharply, with crowding nearing July highs. As each batch of positive data emerged, and the Dollar Index hit 103, some longs started to take profit and exit. The market dynamic of “buy the rumor, sell the fact” forged the inverted V-shaped movement.

What factors should we watch out for in the Dollar's next moves?

• Whether US equities continue to fall. If it’s just a few days of decline followed by sustained rebound, renewed rate hike expectations will favor the Dollar Index; only persistent, weekly-level declines could truly lower US rates and the Dollar Index via the fed put logic.

• Midterm elections and Federal Reserve independence. Expectations are rising that the Republican party will lose both chambers in the midterms, which may already be partially priced into the Dollar Index. However, if the October FOMC, faced with ultra-high September CPI and PPI, still refuses to hike rates in deference to the election, the Federal Reserve’s credibility could be damaged, potentially triggering a new wave of “de-dollarization”—posing an even larger downside risk for the Dollar.