Dollar dips on slowing US economic growth

Important calendar events

• JPY: Tokyo Core CPI, Unemployment Rate, Preliminary Industrial Production, Retail Sales, Housing Starts
• EUR: French Final Private Payrolls, German Retail Sales, French Consumer Spending, French Preliminary CPI, French Preliminary GDP, Core CPI Flash Estimate, CPI Flash Estimate
• GBP: M4 Money Supply, Mortgage Approvals, Net Lending to Individuals
• USD: Core PCE Price Index, Personal Income, Personal Spending, Chicago PMI

USD

The dollar dipped on Thursday and the dollar index retreated to 104.7. US treasury yields remained steady, with the US 10-year bond yielding approximately 4.56%.

Signs that US economic growth slowed down drove the dollar down on Thursday. Preliminary GDP data released on Thursday showed that the US economy expanded by just 1.3% in the first quarter of the year falling considerably below the 3.4% expansion registered in Q4 of 2023. Advance GDP data had previously indicated that the US economy expanded by 1.6% in the year's first quarter. Still, this estimate was revised lower primarily due to reduced consumer spending. The US economy is expanding at an increasingly slower pace putting pressure on the dollar, as GDP data have shown expansion by 4.9% in the third quarter of 2023. In addition, the Preliminary GDP Price Index rose by just 3.0% in Q1, which represents a downward revision of 0.1% from the previous estimate.

Pending US Home Sales estimates, which represent the change in the number of homes under contract to be sold were also released on Thursday. Pending Home Sales estimates contracted by 7.5% in April, falling below expectations of a 1.1% contraction and an expansion of 3.6% in March.

The US inflation outlook remains in focus this week with the Core PCE Price index due on Friday. This is the Federal Reserve’s preferred inflation gauge and may affect the Fed’s rate outlook. Core PCE Price index is forecast to drop to 0.2% in April from 0.3% in March. If market estimates come true, this will indicate that inflationary pressures in the US are easing, putting pressure on the dollar. On the other hand, however, a higher-than-expected print will indicate that inflationary pressures in the US remain high, delaying Fed rate cuts until November or December.

One of the key factors that are driving the dollar right now is the US rate outlook. The US Federal Reserve kept interest rates unchanged at its latest policy meeting, within a target range of 5.25% to 5.50%, as expected. The US Federal Reserve has held interest rates steady since last July. Fed chair Jerome Powell stated that, while future rate hikes are unlikely, US inflation has not cooled sufficiently to allow the central bank to proceed with rate cuts. 

Odds of a rate cut in September have dropped below 50% as Fed policymakers have expressed disappointment in the progress of disinflation in the US. Fed officials have stressed that more evidence of cooling inflation is required before a policy change can be considered.

Currently, only 25-50 basis points of rate cuts are priced in within the year. Market expectations of rate cuts are becoming more moderate as policymakers have stated that they intend to start reducing interest rates slowly. The uncertainty around Fed rate expectations is likely to continue in the coming months causing volatility in Forex markets.  

US CPI data for April showed that disinflation in the US is finally progressing. Monthly inflation rose by just 0.3% in April, falling below expectation of a 0.4% raise. More importantly, headline inflation in April eased to 3.4% on an annual basis from 3.5% in March, which was in line with expectations. Core inflation, which excludes food and energy, came in at 3.6%, its lowest reading in three years.

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EUR 

The EUR/USD rate surged to 1.084 on Thursday as the dollar weakened. If the EUR/USD pair declines, it may find support at 1.076, while resistance may be encountered near 1.089.

German CPI data released on Wednesday showed that German inflation rose to 2.4% year-on-year in May from 2.2% in April. Monthly inflation in Germany, however, rose by only 0.1% in May against expectations of 0.2% and a 0.5% print in April. Markets are now awaiting the Euro area inflation report due on Friday.

Euro area inflation remained steady at 2.4% in April. Core CPI, which excludes food and energy, dropped to 2.7% in April from 2.9% in March. Flash CPI estimates for May are due on Friday and may play a pivotal role in the ECB’s rate outlook. Easing price pressures in the Eurozone may encourage the ECB to start lowering borrowing costs at the next ECB meeting next week.

The ECB left all policy settings unchanged at its latest monetary policy meeting. The European Central Bank kept interest rates unchanged at 4.50% but hinted at a dovish shift in the future. In their statement after the meeting, policymakers stressed that if Euro area inflation remains on a path to achieve the central bank’s 2% target, it would be appropriate to reduce the current level of monetary policy restriction. 

The ECB is expected to start cutting interest rates at the next policy meeting in June since inflationary pressures in the Euro area are easing. ECB President Christine Lagarde has expressed confidence that Euro area inflation is under control and has pointed to a rate cut in June.

ECB member Francois Villeroy de Galhau pointed to a rate cut at the policy meeting next week and hinted at further rate cuts down the road. 

The Euro is under pressure by expectations that the ECB will start lowering interest rates in June. The Fed is not likely to start cutting interest rates before July, putting the Euro at a disadvantage against the dollar. In addition, markets are currently pricing in 25-50 basis points of Fed rate cuts within 2024, compared to 65 bps of ECB rate cuts.

Markets are pricing in a 25-bp rate cut at the upcoming ECB policy meeting in June, while most market analysts forecast around 75 basis points of cuts this year. Markets are pricing in an ECB rate cut at June’s meeting next week, especially if this week’s EU CPI figures show a drop in inflation.

The Eurozone economy expanded by 0.3% in the first quarter of the year, which was in line with preliminary estimates. GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero. The EU economy contracted by 0.1% in the third quarter of 2023 and barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1. 

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GBP 

GBP/USD rose to 1.274 on Thursday as the dollar dipped. If the GBP/USD rate goes up, it may encounter resistance near 1.280, while support may be found near 1.266. 

The British inflation report released last week showed that inflationary pressures in the UK are not easing as fast as anticipated. British headline inflation eased to 2.3% in April on an annual basis from 3.2% in March from 3.4%, exceeding expectations, however, of a more drastic drop to 2.1%. Annual Core CPI, which excludes food and energy, fell to 3.9% in April from 4.2% in March, again surpassing expectations of a 3.6% print. 

The BOE had updated its inflation outlook earlier this year, predicting that inflation would drop to the BOE’s 2% target in the second quarter of the year. The BOE’s forecasts were not confirmed, however, which may force BOE policymakers to keep interest rates at restrictive levels for longer. 

The BOE kept interest rates steady at its latest monetary policy meeting. The BOE maintained its official rate at 5.25% but showed signs of preparing for a dovish pivot. Markets this week will focus on BOE Governor Andrew Bailey’s speech on Thursday for insight into the timing of the central bank's first interest rate cut.

The Sterling gained strength after the release of the UK inflation report last week as market expectations of BOE rate cuts dropped. Market odds of a rate cut in June dropped sharply from 50% to 15% and the probability of a rate cut in August also decreased. Currently, a rate cut by November is fully priced in. Rate cut expectations shifted from two rate cuts and a total of 50 basis points of rate cuts in 2024 to a single rate cut and only a 25 bp reduction in rates within the year. 

The British economy slipped into recession last year, contracting by 0.3% in the final quarter of 2023. Monthly GDP data for February released last week, however, revealed that the British economy has narrowly avoided slipping into recession and has expanded by 0.1%. More importantly, January’s GDP was revised upwards to show an expansion of 0.3%. The British economy is fragile and may force the BOE to pivot to a more dovish policy.

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JPY

The Yen benefited from the dollar’s decline on Thursday and USD/JPY dropped to the 156.5 level. If the USD/JPY pair declines, it may find support near 155.2. If the pair climbs, it may find resistance near 158.5.

The Yen’s weakness is causing concern to Japanese officials who have been warning traders against speculative short selling of the Yen. Yen intervention concerns remain high, as Japanese authorities have been warning repeatedly that an intervention to support the currency might be imminent. Japanese authorities have intervened to support the currency in the past and may do so again if the Yen continues to decline. Concerns about an imminent intervention have been keeping Yen short sellers in check, providing some support for the currency. 

The BOJ kept all policy settings unchanged at its latest policy meeting, despite the Yen’s recent weakness. The BOJ had pivoted to a more hawkish policy at its previous meeting in March, ending its negative interest rate policy and raising the benchmark interest rate into the 0% - 0.1% range. The Yen continues to weaken as there is still a significant disparity between interest rates offered by the BOJ and those from other major central banks. BOJ Governor Kazuo Ueda stated on Monday the central bank would proceed cautiously with moving towards a more hawkish policy, as this would affect the country’s ultra-low inflation rate.

On the data front, inflation in Japan continues to decline. Headline inflation dropped to 2.2% year-on-year in April from 2.6% in March, which was in line with expectations. BOJ Core CPI dropped to 1.8% on an annual basis in April, falling short of expectations of 2.2% and dropping from 2.2% in March according to data released on Tuesday. Low inflation in Japan is preventing the BOJ from raising interest rates putting pressure on the Yen.

Preliminary GDP data for Q1 of 2024 for Japan showed that the country has slipped into recession. Japan’s economy shrank by 0.5% in the first quarter of the year against expectations of a 0.3% drop. Japan’s economy registered a small expansion by 0.1% in the final quarter of 2023, showing that the country’s economy is shrinking. Recession concerns limit the odds of a BOJ hawkish pivot in the coming months.

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Written by:
Myrsini Giannouli

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