Dollar boosted by strong US bond yields

Important calendar events

• JPY: Household Spending
• EUR: German Factory Orders, Spanish Unemployment Change, Retail Sales
• GBP: Construction PMI
• USD: ISM Services PMI, Beige Book

USD

The dollar soared on Tuesday, with the dollar index rising to 104.8. US Treasury yields also rose on Tuesday, boosting the dollar, with the US 10-year bond yielding 4.26%. 

The dollar is expected to be driven in the next few weeks by Fed rate hike expectations. The U.S. Federal Reserve raised interest rates by 25 basis points in July to a target range of 5.25% to 5.50%, the highest level in 22 years. 

Federal Reserve Chair Jerome Powell, recently speaking at the Jackson Hole Symposium in the US, warned that the Fed is prepared to raise interest rates further to bring inflation down. The Fed’s aggressively hawkish policy over the past year has been paying off and inflationary pressures in the US are easing. Most investors are anticipating a pause in rate hikes, but the US central bank has signaled that further tightening is possible if inflation does not go down consistently. 

Headline inflation rose to 3.2% in July from 3.0% in June, versus the 3.3% forecast, indicating that inflationary pressures are not decreasing consistently. US monthly CPI and Core CPI, which excludes food and energy, both rose by 0.2% in July. PPI, and Core PPI, also increased more than expected in July, both rising by 0.3%, against estimates of a 0.2% growth. 

Core PCE Price Index, which is the Fed’s preferred inflation gauge, fell within market expectations last week. Core PCE remained high, rising by 0.2% monthly in July, bringing the annual rate to 4.2%.

Prolonged economic tightening has put considerable strain on the US economy. Preliminary GDP for the second quarter of 2023 showed that the US economy expanded by only 2.1% against expectations of 2.4% growth. The preliminary GDP price index for the 2nd quarter of the year also came in below expectations at 2.0% versus 2.2% anticipated.

US ISM Services PMI data are scheduled to be released on Wednesday and may cause volatility in the price of the dollar as they are important indicators of economic activity and health.

Several FOMC members are due to deliver speeches throughout the week, which may affect the dollar. Market participants are expected to follow FOMC members’ addresses closely for hints into the Fed’s future policy direction.

TRADE USD PAIRS

EUR 

The EUR/USD rate declined on Tuesday, touching the 1.070 level as the dollar gained strength against rivaling currencies. If the EUR/USD pair declines, it may find support at 1.066, while resistance may be encountered near 1.094. 

The Services sector in the Eurozone appears to be deteriorating, driving the Euro down. ISM Services PMI data released on Tuesday for some of the EU’s leading economies, and for the Eurozone as a whole, were disappointing. The Services sector remained in contractionary territory in August, with a print below the threshold of 50 that indicates industry expansion. August’s print of 47.9 was lower than July’s reading of 48.3, indicating that the health of the sector is deteriorating more rapidly.

ECB President Christine Lagarde delivered a speech on Monday at an event hosted by the European Economics and Financial Centre, in London. Lagarde’s speech was non-committal on Monday, avoiding addressing the central bank’s rate decision next week. 

Lagarde speaking at the recent Jackson Hole Symposium in the US, stressed that the Central Bank’s focus remains on attaining the 2% inflation target. Lagarde’s stance was decidedly hawkish, emphasizing that the ECB’s priority remains to keep inflation constrained. Lagarde stated that interest rates will remain high as long as necessary to bring inflation back down to the ECB’s target. 

The ECB raised interest rates by 25 bp at its July policy meeting, bringing its main refinancing rate to 4.25%. The ECB’s forward guidance was not as decisively hawkish as anticipated, though. The central bank hinted that future rate decisions will be data-based. 

Preliminary GDP data for the second quarter of the year showed that the Eurozone economy expanded by 0.3%, exceeding expectations of 0.2% growth, after contracting by 0.1% in Q1 of 2023.  

Flash CPI data for August showed that Euro Area headline inflation remained unchanged at 5.3% year-on-year against expectations of a drop to 5.1%. Core CPI, which excludes food and energy, however, dropped to 5.3% from 5.5% in July. Inflationary pressures in the Eurozone remain high, increasing the likelihood that the ECB will continue its policy of monetary tightening.

TRADE EUR PAIRS

GBP

GBP/USD dropped sharply in early trading on Tuesday but pared some losses later in the day, settling near the 1.256 level. If the GBP/USD rate goes up, it may encounter resistance near 1.274, while support may be found near 1.252. 

Final Services PMI data released on Tuesday for the UK were optimistic, providing support for the Sterling. Services PMI data remained below the threshold of 50 which denotes industry expansion on Tuesday. August’s print, however, came in at 49.5, which was significantly higher than expected and higher than July’s print of 48.7. Even though the Services sector in the UK remains in contractionary territory, the deterioration of the sector is slowing down.

The BOE raised interest rates by 25 basis points at its latest policy meeting, bringing the bank rate to a 15-year high of 5.25%. BOE Governor Andrew Bailey has stressed that interest rates will likely stay higher for longer than previously thought to bring down inflation. Speaking at the annual Jackson Hole Economic Policy Symposium in the US, BOE Deputy Governor Ben Broadbent also stressed that monetary policy may have to remain in restrictive territory for some time yet. Market odds are in favor of another 25-bp rate hike in September followed by another in November.

High inflation in the UK is putting pressure on BOE policymakers to increase interest rates. Inflation in the UK is showing signs of cooling, demonstrating the effectiveness of the BOE’s consistently hawkish policy. Headline inflation dropped to 6.8% year-on-year in July from 7.9% in June. Core CPI, which excludes food and energy, remained steady at 6.9% though. Even though inflationary pressures in the UK are easing, inflation is still high, and policymakers are likely to continue raising interest rates to bring it down. 

Britain’s economy unexpectedly expanded by 0.5% month-on-month in June after contracting by 0.1% in May, beating estimates of a 0.2% growth. Preliminary GDP estimates for the second quarter of the year were also optimistic, predicting a 0.2% growth from just 0.1% in the first quarter of 2023. The state of the British economy is still precarious though, as prolonged tightening has taken its toll on the labor market and other vital economic sectors. 

TRADE GBP PAIRS

JPY

USD/JPY rose to a six-month peak on Tuesday, touching the 147.8 level as the dollar gained strength. If the USD/JPY pair declines, it may find support near 144.4. If the pair climbs, it may find resistance at 148. 

The Yen has been weakening, pushed down by the BOJ’s ultra-accommodating monetary policy. The Yen’s weakness has been the subject of concern for Japanese authorities as it undermines the country’s importing potential and causes financial distress in households. Japanese authorities have been repeatedly warning speculators against excessive short-selling of the Yen. The Yen’s continued weakness is raising market awareness of another intervention by the Japanese currency to support the ailing currency. 

The BOJ recently showed signs of relaxing its ultra-easy policy recently. The central bank maintained its short-term interest rate target steady at -0.10% at its latest policy meeting in July. The BOJ, however, has loosened its yield curve control. This will maintain the rate ceiling but effectively allow rates to float beyond the cap, allowing for rises by a further 50 basis points. 

National Core CPI dropped to 3.1% in July from 3.3% in June. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. BOJ Core CPI dropped slightly to 3.0% in July from 3.1% in June. 

BOJ Governor Kazuo Ueda, speaking at the Jackson Hole symposium in the US defended the BOJ’s ultra-easy policy. Ueda stressed that underlying inflation in Japan remains below the BOJ’s target, indicating that a pivot in the central bank’s policy direction is not on the cards just yet.

Final GDP data for the first quarter of the year showed that the Japanese economy expanded by 0.7%, against a preliminary GDP print of 0.4%. The GDP data exceeded expectations, alleviating recession concerns for Japan. Final GDP Price Index showed a 2.0% annual expansion, versus 1.2% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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