Dollar plummets after US inflation surprises on the downside

Important calendar events

• JPY: Revised Industrial Production
• EUR: German Retail Sales, German WPI, French Final CPI
• USD: PPI and Pore CPI, Preliminary UoM Consumer Sentiment, Prelim UoM Inflation Expectations
• GBP: Monetary Policy Report Hearings

USD

The dollar plummeted after the release of the US inflation report on Thursday and the dollar index dropped to the 104.3 level. US treasury yields also dipped, with the US 10-year bond yielding approximately 4.22%. 

The dollar plunged after US inflation surprised on the downside on Thursday. Headline inflation cooled to 3.0% year-on-year in June from 3.3% in May against expectations of a 3.1% reading. Monthly inflation shrank by 0.1% in June against the 0.1% growth expected. Core inflation, which excludes food and energy, rose by just 0.1% in June from 0.2% in May dropping below expectations of 0.1% growth. Signs that inflationary pressures are easing might induce the Fed to start cutting interest rates in September.

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 policy meeting in June, 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 testified on the Semi-Annual Monetary Policy Report before the US Senate Banking Committee on Tuesday and Wednesday. In his testimony on Tuesday, Powell stated that the Fed remains focused on ensuring price stability in the US. Powell’s testimony on Wednesday was more dovish, boosting the dollar. He said that inflationary pressures in the US are easing and warned that keeping rates at restrictive levels for too long could weaken the economy, hinting at a rate cut in September. 

However, markets were anticipating a more dovish stance, and odds of a rate cut in September dropped from 75% to 70%. However, rate cut expectations in September were catapulted above 85% after the release of the US inflation report on Thursday, putting pressure on the dollar. The uncertainty around Fed rate expectations is likely to continue in the coming months causing volatility in Forex markets.

On the data front, Final GDP data showed that the US economy expanded by just 1.4% in the first quarter of the year, which was in line with expectations. Economic growth in the US is slowing down, falling considerably below the 3.4% expansion registered in Q4 of 2023. 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. 

US CPI data for May showed that disinflation in the US is finally progressing. Monthly inflation remained the same in May, after rising by 0.3% in April and against expectations of a 0.1% rise. Headline inflation eased to 3.3% year-on-year in May from 3.4% in April, dropping below expectations of a 3.4% print. Core inflation, which excludes food and energy, rose by just 0.2% in May versus 0.3% anticipated. Annual Core CPI came in at 3.4% versus 3.6% expected, its lowest reading in three years.

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EUR 

EUR/USD surged to the 1.088 level on Thursday as the dollar weakened. If the EUR/USD pair declines, it may find support at 1.073, while resistance may be encountered near 1.091.

The ECB lowered its Main Refinancing Rate by 25 basis points to 4.25% in June. Eurozone inflation remains sticky and may slow down the pace of future rate cuts. ECB President Christine Lagarde has stated that the central bank’s policy will remain data-driven. 

German CPI data released on Thursday were in line with expectations and did not affect Euro price significantly. Inflation in the Eurozone’s leading economy remained steady in June, rising by 0.1% as expected.

Eurozone inflation eased to 2.5% in June from 2.6% in May putting pressure on the Euro. Core CPI, which excludes food and energy, however, rose by 2.9% on an annual basis in June against expectations of a 2.8% print. 

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.

The Euro has been under pressure since political turmoil in France led to national elections. The first round of French national elections took place on June 30th and the second round on July 7th.

Marine Le Pen’s far-right Party won the first round of France's parliamentary elections, securing 34% of the votes. Le Pen’s National Rally party, however, suffered a surprising defeat in the second round on Sunday, putting pressure on the Euro. The Left-wing coalition gained the most seats in the National Assembly. The Left-wing party, however, did not win an outright majority required to form a government. Last week’s election result has led to a hung parliament and concerns of political instability in France are putting pressure on the Euro.  

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GBP 

The Sterling benefitted from the dollar’s weakness on Thursday and GBP/USD rose to a four-month high of 1.295. If the GBP/USD rate goes up, it may encounter resistance near 1.313, while support may be found near 1.267. 

The Sterling gained strength after the Labour Party achieved a landslide victory at the British national elections last week. Keir Starmer's center-left Labour Party won 410 of the 650 seats in the parliament and will form the next British government. Former Prime Minister Rishi Sunak's Conservatives secured just 119 seats. The Labour Party’s decisive victory is raising hopes of political stability in the UK boosting the sterling.

The BOE kept interest rates steady at its latest monetary policy meeting in June. The BOE maintained its official rate at a 16-year high of 5.25. The BOE's Monetary Policy Committee voted 7-2 to keep rates on hold with two members voting to cut interest rates by 25 basis points.

Markets are pricing in a rate cut in September with approximately 70% probability, while a rate cut by November is fully priced in. Rate cut expectations have shifted from two rate cuts and a total of 50 basis points of rate cuts in 2024 to approximately 35 bp reduction in rates within the year. 

BOE chief economist Huw Pill stated on Wednesday that price pressures in the UK remain persistent. BOE rate cut odds dropped after Pill’s comments, boosting the Sterling.

GDP data released on Thursday showed that the British economy is showing signs of improvement, further reducing the odds of a dovish pivot by the BOE. GDP data showed that the British economy expanded by 0.4% in May following stagnation the month before and against expectations of 0.2% growth. Moreover, the British economy expanded by 0.7% in the first quarter of the year against initial estimates of 0.6% growth. The UK slipped into recession last year as the economy contracted by 0.3% in the final quarter of 2023. 

Price pressures in the UK are easing, raising the odds of a BOE rate cut by September. British headline inflation eased to 2.0% on an annual basis in May from 2.3% in April, which was in line with expectations. Annual Core CPI, which excludes food and energy, fell to 3.5% in May from 3.9% in April. British inflation dropped to the BOE’s target for the first time in nearly three years indicating that the BOE’s hawkish monetary policy has been paying off. 

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JPY

USD/JPY plummeted on Thursday, dropping to the 159.0 level. If the USD/JPY pair declines, it may find support near 155.6. If the pair climbs, it may find resistance near the psychological level of 162.0.

The Yen has been under pressure since the BOJ disappointed expectations of a hawkish shift at its latest meeting. The BOJ pivoted to a more hawkish policy at its 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 has hinted that the central bank would ease its bond purchasing at the next meeting in July. BOJ officials, however, had not given any specifics for paring back their bond-buying program till now. The BOJ released on Tuesday a summary of opinions collected in a survey of bond market participants. The BOJ’s summary of opinions reflects the market’s inclination to curtail the central bank's bond-purchasing program. A growing demand among bond market participants for tapering of BOJ bond purchases might induce the central bank to pivot to a more hawkish policy. 

BOJ officials have been attempting to boost the Yen, warning traders against speculative short selling of the currency. Threats of an intervention, however, have been issued for many months now and no longer have a significant impact on markets. The BOJ intervened to support the Yen in 2022 and again this year in late April and early May, when USD/JPY surged above the 160.0 level. 

On the data front, inflation in Japan remains weak but rising. Headline inflation rose to 2.5% year-on-year in May from 2.2% in April. BOJ Core CPI rose to 2.1% on an annual basis in May from 1.8% in April, exceeding expectations of 1.9%. Rising inflation in Japan increases the odds of another BOJ rate hike later in the year. Tokyo Core CPI rose to 2.1% year-on-year in June from 1.9% in May against estimates of a 2.0% reading. 

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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