U.S. Dollar's Recent Recovery May Have Legs, but Don't Bet on Comeback, Analysts Warn

The dollar index, which tracks the U.S. dollar's value against a basket of fiat currencies, has seen a notable bounce following its worst six months in decades. Analysts, expected further gains in the short-term, but ruled out a full-blown bullish trend.

The DXY has gained 1.40% to 98.30, bouncing off the three-year low of 96.37, according to TradingView. The recovery qualifies as a bullish technical breakout, as the index has topped the trendline connecting the series of lower highs from the February peak.

A strong dollar typically leads to financial tightening worldwide, zapping investor risk appetite. Historically, bitcoin has mostly moved in the opposite direction of the dollar.

The DXY's latest breakout, however, looks to be a temporary technical correction – a fleeting bounce seen following a notable slide, according to Marc Chandler, chief market strategist at Bannockburn Capital Markets, and the author of "Making Sense of the Dollar."

"The dollar's first back-to-back weekly gain since mid-May has been helped by the stronger than expected data and a rise in U.S. rates. The implied year end rate in the Fed funds futures market has risen by almost 25 bp this month.," Chandler said.

Analysts at ING said that the dollar may find support in the coming months as the 14 basis points of easing (rate cut) priced for the September contract unwinds against the backdrop of upbeat U.S. data and uncertainty surrounding the Japanese election.

"Retail sales and jobless claims were better than expected yesterday, offering more support for a hawkish rethink of Federal Reserve rate cuts. We expect the residual 14bp priced in for September to be gradually reduced and add pressure on EUR/USD. Elsewhere, Japan’s election on Sunday might trigger a break above 150.0 in USD/JPY," analysts at ING noted.

Focus on Japan's Upper House Election

Japan's Upper House election due Sunday is likely driving outflows from Japanese assets and pushing the DXY higher.

According to ING, investors are worried that Japan's ruling coalition may fail to secure a majority, resulting in political uncertainty and affecting Japan's ability to negotiate with the U.S. on tariffs and fiscal stability. Ahead of the elections, politicians have promised tax cuts and cash handouts, which are likely to worsen fiscal issues.

"The ruling coalition needs a minimum of 50 seats out of 125 contested in order to secure a majority in the Upper House. However, recent polls indicate that there is a significant possibility that the Liberal Democratic Party and Komeito will fall short," ING noted, adding that the possibility of a sooner than expected Bank of Japan rate hike is another source for jitters in Japanese markets.

But, according to Griffin Ardern, head of options trading and research at crypto financial platform BloFin, investors' aversion to the yen is likely to be short-lived.

"The macroeconomic fundamentals of the United States have not improved significantly. The data have confirmed the rebound in US inflation, and Trump's threats to Powell, as well as the passing of the OBBBA bill, have led to a further increase in inflation expectations," Ardern said.

OBBA stands for the recently approved one big beautiful bill in the U.S thats expected boost fiscal deficit by $3 trillion over coming years.

"As the uncertainty in Japan decreases, DXY's performance is likely to return to decline," he added.