In the absence of new information, the dollar lacks significant downward drivers in the short term.

Written by: Xu Chao, Wall Street Insights

The Fed's unexpectedly hawkish statements provide the strongest short-term support for the dollar, but ongoing geopolitical conflicts and political pressure from the upcoming midterm elections leave market uncertainty high, resulting in low confidence in directional judgments in the currency market.

The Fed's September meeting sent a strong hawkish signal, with market reactions exceeding prior expectations. According to Citigroup Research, the results of the September meeting have transformed the October meeting into a "live meeting," with the market currently pricing in an additional approximately 13 basis points rate hike in October. The technical pattern of the dollar index (DXY) has strengthened accordingly, confirming a double bottom, targeting 101.15.

Citigroup Research points out that the current macro combination of the dollar—high yields combined with pressured stocks—is historically the most favorable market condition for the dollar. At the same time, the euro, Swiss franc, Swedish krona, and New Zealand dollar are all facing downward pressure, and the euro to dollar exchange rate may retest the 1.13 low.

Hawkish Expectations Surpass, Rate Hike Expectations for October Heat Up

Citigroup Research's previous baseline judgment was that the Fed would struggle to "outperform" the market's hawkish pricing of its policy path, posing a risk of disappointing the market. However, this FOMC meeting led by Waller completely broke this prediction.

This meeting not only confirmed a rate hike but also the hard-line nature of its forward guidance prompted the market to reassess the subsequent path. The probability of a rate hike in October has significantly increased, with market pricing already factoring in approximately 13 basis points of additional tightening expectations.

Citigroup Research believes that although there is a risk that pricing may be ahead of reality, this tightening expectation may continue to support U.S. Treasury yields and the dollar before the geopolitical conflict is clarified.

Geopolitical Conflicts and Midterm Elections Constitute Ongoing Variables

The geopolitical situation is another core variable in the current currency market.

According to a Reuters report on September 9, Trump stated that the Iran war may end after the U.S. midterm elections, aligning with Citigroup Research team's previous judgment: the November midterm elections may become a flashpoint, and Iranian leaders may have motives to raise energy prices before the elections.

The spot premium signals in the energy market confirm this judgment. Citigroup Research states that the spread between spot Brent crude oil and futures contracts Brent (spot premium) has significantly widened again, indicating tight supplies in the physical market. As the conflict extends to the Strait of Hormuz and east-west oil pipelines, this tension is unlikely to ease in the short term. Analysts note that if the situation shows a significant easing, this premium may quickly narrow, but the possibility is relatively low before the midterm elections.

The Dollar Technicals Confirm a Double Bottom, but Key Resistance Levels Are Close

From a technical perspective, the DXY's performance provides support for dollar bulls. Citigroup Research points out that the current price pattern has confirmed a double bottom structure, targeting 101.15, similar to the double bottom pattern from April to May—during which DXY overshot to 101.80 after completing the double bottom. If this trend replicates the same path, the euro to dollar exchange rate will subsequently fall back to the 1.13 low range.

However, the upward space is not completely unobstructed. Citigroup Research marks the 102.20 to 102.50 range as a key resistance zone, which closely aligns with the 200-week moving average and historically significant long-term trend lines. Analysts explicitly state that this is not a target price level, but a reminder for investors to pay attention to the looming resistance wall after a potential dollar overrun.

Stock Market Pressured Alongside Cooling AI Narrative, Dollar Gains Additional Support

The performance of the equity market provides additional support for the dollar.

Citigroup Research indicates that market fluctuations during the initial stage of rate hikes are historically normal, and the U.S. stock market has begun to show this sign. In the longer term, resistance on social and political levels surrounding artificial intelligence, along with the uncertainty of model development pace, may continue to suppress market sentiment before the midterm elections.

Citigroup's U.S. equity strategy team maintains a bullish judgement driven by earnings before the end of the year, but acknowledges that during the gap before earnings season arrives, the combined pressure of negative AI narratives, high interest rates, and geopolitical risks may keep the market in a state of high volatility.

Citigroup emphasizes that the combination of rising yields and falling stocks is historically the most favorable macro state for the dollar, and the current market is in this state, with potential for further follow-up in the coming days.

Beware of Rapid Reversal of Situation

Although the logic for a bullish dollar in the short term is clear, Citigroup's research team repeatedly stresses that there is a risk of reversal in the overall judgment. First, the market has priced in a significant amount regarding this FOMC, leading to diminishing marginal positive effects; second, the PCE statistical method adjustment remains a potential variable yet to be digested; third, price movements on the Fed's decision day have historically been highly volatile and should not be overly interpreted.

Citigroup concludes that in the absence of new information, the dollar lacks significant downward drivers in the short term, and the path for the euro to dollar exchange rate to retest the 1.13 low remains open. However, under the current market conditions, the situation can fundamentally change in a very short time, and investors should avoid overly betting on a single direction.