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Why the Fed Is a Dollar Catalyst
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The currency market has traded $9.6 trillion a day on average, more than any other market.
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As you can imagine, currency moves can have a spillover impact on stocks, bonds, precious metals, and cryptocurrencies.
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The U.S. Dollar Index (DXY) is a popular way to measure movements in the dollar against a basket of other major currencies. That includes the euro, British pound, and Japanese yen.
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Here’s a chart of DXY going back to the start of 2025:
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DXY made a peak near the 110 level in January 2025 and began a steady decline. The pullback handed the dollar one of its worst starts in over 50 years.
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After finding a low in July last year, the dollar has been grinding sideways in a range. But the Fed could play a major role in pushing the dollar out of that range.
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With inflation pressures persisting and fears over job weakness not materializing, the Fed could be facing a hawkish pivot toward tighter monetary policy and rate hikes.
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The outlook for monetary policy is developing alongside a bullish chart setup in DXY, which could spark a dollar rebound.
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Here’s the chart setup you need to watch…
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Watch DXY for a Dollar Reversal
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While DXY has been range-bound, the Fed meeting this week could play a major role in sparking a move.
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Interest rate shifts around the world can impact currency pairs. Interest rates are a fundamental part of currency trading, acting like a relative valuation tool.
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Capital flows to where it can earn the best return, so countries with relatively high interest rates tend to attract capital (and see their currency appreciate), while countries with low rates will often see their currency fall in value.
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That’s why the Fed could be a big catalyst for currency markets when it meets. Expectations are growing that the Fed will need to raise interest rates to help keep inflation under control.
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At the same time, a bullish reversal pattern is forming on DXY. Take another look at the short-term DXY chart:
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A recent pullback in DXY saw the dollar get extended far below its 50-day moving average (blue line). At the same time, a positive momentum divergence is forming on the Relative Strength Index (RSI).
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While DXY is testing the 98.60 level for the second time since the end of August, the RSI is making a higher low, which shows downside momentum is fading (dashed lines).
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Dollar movements can have a ripple effect throughout the stock market. So as the DXY chart setup collides with a highly anticipated Fed meeting, stay on the lookout for a reversal higher.
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One way or another, any big or unexpected moves this week could create a tailspin of volatility with plenty of trading opportunities.
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Happy Trading,
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Larry Benedict
Editor, Trading With Larry Benedict
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