Dollar gains strength on robust US labor data

Important calendar events

• JPY: Tokyo Core CPI, Unemployment Rate, Preliminary Industrial Production, Retail Sales
• USD: Goods Trade Balance, Preliminary Wholesale Inventories

USD

The dollar strengthened on Thursday, and the dollar index rose to 108.5. US treasury yields edged lower, with the 10-year bond yield dropping from 4.61 to 4.57%. 

US labor data released on Thursday were optimistic, boosting the dollar. US unemployment Claims dropped to 219K for the week of December 20 from 220K the week before and against expectations of a 223K print. 

The US Federal Reserve cut interest rates by 25 basis points last week to a target range of 4.25% to 4.50%. However, a 25-basis point rate cut had been fully priced in, and market participants focused mostly on the Fed’s forward guidance.

Fed Chair Jerome Powell delivered a hawkish message after the policy meeting, emphasizing the need to be cautious about further rate cuts. Powell stated that the Fed’s approach will remain data-driven and hinted that future rate cuts will be slower, as inflation in the US remains above the central bank’s 2% target. 

The Fed’s Summary of Economic Projections, or dot plot, was also released after the policy meeting. This is a chart that is updated quarterly and records each Fed official's projection for the central bank's interest rate. The Fed’s updated dot plot last week was more hawkish than anticipated, bringing down expectations of future rate cuts. The Fed’s latest dot plot indicated that only two rate cuts will take place in 2025, down from four projected in September. In quantitative terms, policymakers expect to deliver a total of 50 basis points of rate cuts in 2025, which will bring the central bank’s interest rate to 3.9% by the end of 2025, which is significantly higher than the 3.4% estimated in September. In addition, the Fed’s projections indicate that a more normalized monetary policy with a 3.4% interest rate will be reached in 2026, indicating a policy shift to a more hawkish stance. 

US inflation is proving to be sticky despite the Federal Reserve’s efforts to bring it down to its 2.0% target. US Headline inflation rose to 2.7% year-on-year in November from 2.6% in October. Monthly inflation rose by 0.3% in November, the same as in October, which was in line with expectations. Core CPI, which excludes food and energy, rose by 0.3% in November. 

Final GDP data for the third quarter of the year showed that the US economy expanded by 3.1% in the third quarter of 2024, up from 2.8% estimated earlier. In addition, the US economy expanded by 3.0% in the second quarter of the year and by 1.4% in the first quarter of the year. 

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EUR 

EUR/USD edged higher on Thursday, rising from 1.040 to 1.042. If the EUR/USD pair declines, it may find support at 1.034, while resistance may be encountered near 1.050.

The ECB lowered its benchmark interest rate by 25 basis points in December, bringing its main refinancing rate to 3.15%. This was the fourth rate cut for the ECB this year, which started its easing cycle in June and has already lowered interest rates by a total of 100 bps. More importantly, ECB President Christine Lagarde hinted at further easing in the coming months as Eurozone inflation nears the central bank’s target while the economy remains weak.

Lagarde’s press conference after the policy meeting was dovish, raising expectations of further rate cuts. Lagarde admitted that several policymakers advocated for a sharper rate cut of 50bps at December’s meeting and market expectations of future ECB rate cuts rose after Lagarde’s speech. The central bank is currently expected to cut interest rates up to five more times next year, to a total of 125bps, until neutral policy settings are reached. 

Eurozone inflation remains above the ECB’s 2% target and may prevent the ECB from cutting interest rates in December. Eurozone inflation rose to 2.3% year-on-year in November from 2.0% in October, which was in line with expectations. Core CPI, which excludes food and energy, remained steady at 2.7% in November, against expectations of a 2.8% print. 

Flash GDP data showed that the Eurozone economy expanded by 0.4% in Q3 of 2024, rising from 0.2% in Q2. The Eurozone economy also expanded by 0.3% in the first quarter of 2024. The economic outlook of the EU remains fragile as prolonged tightening has brought the Euro area economy to the brink of recession.

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GBP

GBP/USD dropped from 1.254 to 1.252 on Thursday, as the dollar gained strength. If the GBP/USD rate goes up, it may encounter resistance at 1.272, while support may be found near 1.247.  

The BOE kept interest rates steady at its policy meeting last week, having cut interest rates twice already this year. MPC members voted 6-3 to keep rates on hold, with three members in favor of cutting interest rates. Last week’s MPC voting shows a shift to a hawkish direction, as policymakers had voted with a strong majority of 8-1 to cut rates to 4.75% in October. 

Bank of England Governor Andrew Bailey reiterated his former message that the central bank needs to adopt a gradual approach to future rate cuts. Bailey also stressed that the BOE’s policy outlook will remain data-driven and refused to commit to a timeline or magnitude of future rate cuts.  

CPI data showed an uptick in British inflation in November. Headline inflation in the UK rose to 2.6% year-on-year in November from 2.3% in October. Core annual inflation, which excludes food and energy, climbed to 3.5% in November from 3.2% in October against 3.6% anticipated. 

Final GDP data released on Monday for the third quarter of the year showed that the British economy is stagnating. Earlier forecasts indicated slight economic growth by 0.1% in the third quarter of 2024, but the British economy is being stifled by high interest rates and cannot expand. 

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JPY

USD/JPY rose above the 158.0 level on Thursday for the first time since June. If the USD/JPY pair declines, it may find support at 148.6. If the pair climbs, it may find resistance at 158.8. 

The BOJ maintained its current monetary policy guidelines steady and its interest rate at 0.25% at its policy meeting last week. BOJ policymakers decided to keep rates unchanged in an 8-1 vote split, as one member voted in favor of a 25-bps hike. 

BOJ Governor Kazuo Ueda stated that Japan’s economic and inflationary outlook remains uncertain and stressed that the central bank’s policy will remain data-driven. The BOJ is likely to hold off raising interest rates in the coming months, putting pressure on the Yen. At the same time, the Fed’s rate outlook has become more hawkish than previously anticipated, boosting the USD/JPY rate.

Inflation in Japan is on the rise, raising the odds of a BOJ rate hike in December and providing support for the Yen. Tokyo Core CPI came in at 2.3% annually in November, beating expectations of 2.0% and far exceeding October’s print of 1.8%. Headline inflation in Japan rose by 2.7% year-on-year in November from 2.3% in October against expectations of a 2.6% print. In addition, BOJ Core CPI rose to 1.7% year-on-year in November from 1.5% in October against expectations of 1.5%. 

Final GDP data for the third quarter of the year showed that Japan’s economy expanded by 0.3%, exceeding initial estimates of 0.2%, but down from 0.7% in the second quarter. The Japanese economy is expanding, after shrinking by 0.5% in the first quarter of the year. 

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Written by:
Myrsini Giannouli

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