Should you buy or sell the dollar after the first collapse of a US bank in 15 years?

Turbulence once again grips financial markets ahead of the US inflation report and the Fed’s interest rate decision. News that the Federal Deposit Insurance Corporation (FDIC) moved to close Silicon Valley Bank on Friday triggered a massive increase in volatility.

Confusion reigns.

On the one hand, the Federal Reserve just suggested last week that it will need to hike the funds rate more than the market’s consensus. On the other hand, the recent events in the US banking sector directly result from the Fed’s aggressive rate hikes over the past year.

Something had to break – and it did. So the big question now is what will the Fed do next? Will it stick to its narrative and focus on inflation only? Or will it start accommodating the policy and end the tightening cycle right here and now?

In the meantime, the US dollar has declined since last Friday. The NFP report triggered a move lower, and the events in the banking sector might imply that no more rate hikes are coming.

But this is a tricky statement. Even if the Fed no longer hikes, the signal it’ll send to markets matters the most. It means that it was forced to change the course of its monetary policy by exogenous events, and thus, investors may seek safety in the world’s reserve currency.  

DXY forms a reversal pattern

The Dollar index (DXY) peaked in October 2022. It traded above 114 and then corrected just as the risk-on sentiment recovered.

But at current levels, one may spot a possible reversal pattern. An inverse head and shoulders suggests that the dollar may have room to strengthen should the DXY break above the pattern’s neckline. If so, the measured move points to 110; from there, there is little or no resistance until a new high.

One thing is sure – the events in the US banking system affect all markets. Bonds have made some historical moves, for instance. Therefore, one should keep an eye open and trade lightly, as volatility is higher than usual.