Interest rates in the U.S. are on the move, and the stakes are high for the biggest financial market in the world.
The Federal Reserve made the first U.S. hike in over three years when it raised interest rates by 0.25% last month.
The U.S. already has one of the highest central bank rates in the world among developed economies. And current market odds favor several more hikes into 2027.
I warned you several weeks ago that rising rates could spark a rally in the U.S. dollar, which is exactly what happened.
Now the move looks stretched and could set up the next trading opportunity…
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The currency market has traded $9.6 trillion a day on average, more than any other market.
The U.S. dollar is the most traded asset in the world, and 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.
I noted last month that interest rate shifts across different countries can impact currency pairs. Interest rates are a fundamental part of currency trading, acting like a relative valuation tool.
Money flows to where it can earn the best return. So countries with higher interest rates tend to attract capital, and their currencies rise. Countries with low rates often see their currencies fall.
Before the Fed met to set rates in September, I had this to say:
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.
At the same time, a bullish reversal pattern is forming on DXY. Take another look at the short-term DXY chart:
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).
That divergence, plus the Fed’s rate hike, sparked a rally in DXY. Subscribers to my Currency Wizard trading advisory were positioned to profit from dollar strength versus the euro, which allowed us to close out our position for a nice 92-pip gain.
But now signs point to DXY getting extended to the upside while the rate outlook is evolving once again.
Here’s the key DXY level coming into play and why it could spark another trading opportunity…
While the Fed is raising interest rates, other developed nations are expected to catch up and close the gap on rates.
The Fed’s preferred inflation gauge – Personal Consumption Expenditures (PCE) – was also reported this week. Core inflation rose by 3% in August, which was much less than expected.
That’s easing fears of a fast rate-hiking cycle, which should be bearish for the dollar.
At the same time, the rally in DXY looks like it has gone too far and is showing signs of exhaustion. Here’s the updated chart:
The rally in DXY has brought it back to the highs from July, which is a resistance level tested a few times going back to 2025.
At the same time, DXY is getting extended far above the 50-day moving average (MA – blue line). The RSI also hit the second most overbought level since the start of 2025.
The dollar rally looks stretched and ready to reverse. Expectations around the Fed following the latest inflation report could become the catalyst for a move once again.
So stay alert. I suspect we’ll have some good trading opportunities as this dynamic plays out in the days ahead.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
P.S. If you missed last night’s event, you get a second shot… The replay of The Dollar Trap Summit is available for a brief time. But given what Jeff Brown and I expect to happen on October 7, there’s not much time left to prepare.
Watch the replay now to learn about the trap… and how you can turn the threat into a profit opportunity…
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
