The latest Consumer Price Index (CPI) data from the United States has generated a noticeable fluctuation in the financial marketThe year-on-year increase was reported at 4.9%, slightly below the expected 5.0%. Meanwhile, core CPI matched expectations with a 5.5% increase year-on-yearThis divergence in data led to significant sell-off pressure on the dollar, although it managed to recover lost ground shortly thereafterThis series of events has raised questions about the consensus surrounding a weaker dollar—suggesting that the path towards its realization may not be straightforward.

Traders currently estimate a mere 10% likelihood of a Federal Reserve rate hike in June, a sharp decrease of approximately 20% from the probabilities assessed prior to the CPI announcementConcurrently, the Bank of England and the European Central Bank (ECB) are both in the process of raising interest rates, while speculation mounts that the Bank of Japan may abandon its Yield Curve Control (YCC) policy

The implications of these maneuvers on mainstream currencies—such as the dollar, euro, pound, Australian dollar, and yen—remain to be seen, particularly regarding the future exchange rate of the Chinese yuan.

The perception of a weaker dollar is likely to take time to materializeThe US dollar index showed a rebound to around 101.9 in mid-May, marking the largest single-day increase since MarchThe possibility of a rate hike in June appears minimal, but the recent corrections of overly aggressive rate cut expectations could pave the way for a dollar rebound in the near future.

Furthermore, there has been an influx of safe-haven capital into the dollar, providing a buffer against its temporary weakeningWorrisome inflation data from China has heightened concerns over the demand from the world's second-largest economy, while fears surrounding the US debt ceiling continue to escalate

If a resolution is not found within the next three weeks, the prospect of a US default looms large—a situation that remains dire and almost unthinkableIt may require adverse market trends to prompt lawmakers into action.

At present, debates rage between those bullish and bearish on the US economic growth, resulting in a volatile range for the dollarAlthough there has been a significant deceleration in monetary growth and negative credit impulse—coupled with a wave of bank failures—the labor market remains markedly tightIn essence, this mirrors the current state of China's economy, which is experiencing a slowdown after an exceptionally robust growth periodThe duration of stagnation in economic growth is difficult to quantify, signifying that while a downtrend for the dollar may seem inevitable, it is likely to follow a pattern of moving 'four steps down and three steps up.'

Looking at the data for April, non-farm payrolls in the US increased by 253,000, with unemployment rates dropping to 3.4%. These figures suggest that the job market remains resilient amid turmoil in the banking sector, rising interest rates, and high inflation rates

However, both the ISM manufacturing and services indices are declining, alongside weakening consumer and small business confidence surveysBalancing the fight against inflation while maintaining financial stability poses a considerable challenge for the Federal ReserveRecent credit surveys from the Fed indicate that major banks tightened credit standards in the first quarter, while both consumer and business demand for loans continues to diminish.

Currently, the dollar index hovers around 102, with models showing that the dollar remains overvaluedFuture movements of the dollar index will be closely tied to the trajectories of the euro and pound, while the performances of the yen and Australian dollar should not be overlooked; these currencies, although smaller in share, can wield substantial influence in the short term.

Looking forward, the euro appears positioned to outperform the dollar in 2023. As the Federal Reserve nears the end of its interest rate hiking cycle, the ECB has committed to ensuring a sufficiently restrictive policy stance to achieve a return to its mid-term inflation target of 2%. In May, the ECB acted to increase rates by 25 basis points, pushing the main refinancing rate, marginal lending rate, and deposit facility rate to 3.75%, 4.00%, and 3.25%, respectively

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A total increase of 375 basis points since last July marks the highest levels seen since October 2008. ECB President Christine Lagarde hinted at further potential hikes, driven by persistent concerns over core inflation rates and stable price increases in services.

There was a period last September when the euro fell below parity against the dollar, hitting a low of 0.9535. After spending some time below this threshold, a sustained upward trend ensued, with current euro/dollar rates stabilizing around 1.09. The rapid ascent seen in March and April has since slowed; following a failed attempt to breach a yearly high of 1.1096 in May, trends indicate a struggle to maintain opening levelsThe relative strength index (RSI) is diverging from price, suggesting a downward trend.

From a technical perspective, a drop below the range of 1.0880 to 1.0940 may propel euro/dollar rates to revisit April lows near 1.0788, with further attention required at the Fibonacci retracement level around 1.0610. Nevertheless, euro/dollar may follow the upward trajectory of the 50-day moving average (1.0861) and maintain support within the 1.0880 to 1.0940 zone, but a closing above the range of 1.1070 (23.6% Fibonacci retracement) to 1.1090 (38.2% Fibonacci extension) and a breakthrough of the April high (1.1096) is necessary to cast a renewed eye towards the March 2022 peak of 1.1185.

The pound, on the other hand, maintains a strong footing amid expectations of continued interest rate increases

The Bank of England announced its latest rate decisions on May 11, confirming a 25 basis point hike, spurred by persistent inflation rates exceeding 10%. This champions the narrative that further hikes are likely to come, propelling the pound's momentum this year.

This marks the Bank of England's twelfth consecutive rate hike, and the decision to tighten policy came as no surpriseThe inflation rate has averaged in the double digits for the last seven months, with only one month dropping below 10%, reverting to 9.9% in August of the previous yearThis indicates a continuing trend of CPI hovering around the 10% mark for three consecutive quarters.

If the Bank of England refrains from action, it risks losing credibility, particularly as the UK's CPI significantly overshoots both the Eurozone at 7% and the US at 4.9%. A critical driver of inflation remains the surge in food prices

Even so, recent data reflects that the UK economy is proving more resilient than anticipated, with an exceptionally tight labor market.

Consequently, the Bank has raised its growth and inflation outlook—shifting from considerations of potential recessionNotably, during the latest meeting, two of the nine voting members proposed a pause in rate hikesDespite revisions of this year’s inflation expectations from 3.9% to 5.1% and signals for further increases, the exchange rate still succumbed to greater downward pressure within the larger cycle, closing down 0.9% to 1.2507.

However, the long-term outlook for the pound/dollar remains bullish, as it is predicted that once the short-term effects of a dollar correction subside, rates could exceed 1.30. In the short term, the possibility of a retreat to 1.25 cannot be ruled out.

On the upside, the next target for an upward move lies slightly above 1.2680, where there may be short-sellers waiting to close positions

Following this, the pound could advance towards around 1.27. Beyond this point, notable targets may lessen in significance, meaning, as long as no fundamental factors trigger a reversal, prices could potentially rise to between 1.28 and 1.30 within the coming days or weeks.

As for the dollar/yen dynamics, the rate has recently tested the critical support level of 134. The dollar/yen has managed to remain above this convergence point, having plummeted from near 150 last year, while the yen retains its upward momentumHowever, the pressing concern is that despite previous anticipations surrounding the Bank of Japan's departure from YCC policies and potential rate hikes, no concrete progress has been madeGiven the long-standing dovish stance of the Bank of Japan, divergences in monetary policy and interest rates are particularly pronounced.

Even under the leadership of new Governor Ueda Kazuo, it appears the Bank of Japan will maintain a negative interest rate environment while tightly adhering to quantitative easing measures for the foreseeable future

Analyzing dollar/yen, the pair is still situated above its short-term bullish trend line and the significant moving average levels around 134. Provided this support level remains intact, the path of least resistance for dollar/yen appears upward, suggesting potential rebounds toward prior resistance at the 138.00 area, while a breach below the support could indicate further corrections towards previous support around 132—inclusive of low points witnessed in March at approximately 130.

Despite a slowing economic recovery, the depreciation of the yuan may be limitedAs of May 12, the dollar/offshore yuan was trading around 6.95, with the yuan showing signs of weakness despite an accelerating GDP recoveryThe yuan has depreciated from approximately 6.7 in the first quarter, edging closer to the 7 threshold once again.

The GDP growth rate for China was recorded at 4.5% for the first quarter, with analysts forecasting a potential growth exceeding 7% for the second quarter

However, recent downward trends in PMI manufacturing indices and weaker trade data have surfacedFurthermore, financial figures released on May 11 reflecting credit data considerably below expectations demonstrate a net credit increase strikingly half of market forecasts, suggesting the first wave of post-pandemic recovery is falteringThe real estate sector's performance is underwhelming, escalating concerns among investors regarding the sustainability of the recovery.

Despite these challenges, it is plausibly held that the likelihood of the yuan breach beyond 7 or further significant depreciation is limitedRecent yuan weakness can be attributed in part to exporters’ reluctance to sell dollar earnings, driven by high-interest rates on dollar deposits, which has resulted in the largest net forex settlement deficit since June 2019. Since the beginning of the year, there has been a consistent increase in foreign exchange deposits.

Simultaneously, when considering the broader context, China remains in a phase of recovery, and the overarching trend of a weakening dollar should form a ceiling on the yuan's depreciation potential, possibly assisting in its strengthening in future trading sessions