Using the DXY to forecast US equities ahead of the December CPI report

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Next week is a busy one for traders. Four central banks will release their monetary decisions (Federal Reserve, Swiss National Bank, Bank of England, European Central Bank) for the last time in 2022.

But before any of these decisions will be known, one piece of economic data might influence financial markets more. That is the December US CPI report.

Schedule for release on Tuesday, the report refers to inflation data for November. The market expects inflation to cool down further and the annual CPI to drop to 7.3% from 7.7%.

Any surprise in the data will move financial markets. For example, in 2022, financial markets moved in a tight correlation, as reflected by the dollar index (DXY) and US equity markets. But if we are to pick which one of the two markets is leading, that would likely be the DXY.

DXY chart by TradingView

US equities bottomed when the DXY topped

In a way, the inverse correlation between the DXY and US equities makes sense – a strong dollar leads to equity markets declining and the other way around. The chart above reflects this powerful correlation that existed in 2022.

Therefore, one might use the DXY as a leading market to forecast the US equity market’s direction.

From a technical perspective, the DXY formed a triangle that acted as a reversal pattern in October. That was also the time when the US equity markets bottomed.

Also, it was the time when US inflation data showed that a peak might be in place. In other words, if inflation data shows further improvements this coming Tuesday, the DXY should give up some more of the 2022 gains, which means that US equities could rally ahead of the holiday season.

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