Important calendar events
The dollar weakened on Wednesday, with the dollar index dropping to the 104 level. US treasury yields remained firm, with the US 10-year bond yielding approximately 4.10%.
The US Federal Reserve kept interest rates unchanged last week, within a target range of 5.25% to 5.50%. The FOMC statement released after the meeting largely resembled the previous versions. Policymakers stated that the economy was expanding at a satisfactory rate and that the labor market remained robust. The statement emphasized that inflationary pressures are easing but inflation remains at elevated levels. The Fed, however, has removed the tightening bias from its policy statement, indicating that the central bank is preparing to pivot to a less restrictive monetary policy. The Fed’s outlook has become dovish, pushing the dollar and treasury yields down.
Fed Chair Jerome Powell was quick to disabuse markets of the notion that rate cuts are imminent. Fed Chair Jerome Powell’s press conference after the meeting attracted a lot of attention as traders focused on the central bank’s forward guidance. In his press conference, Powell discounted the possibility of a rate cut in March.
The US dollar and treasury yields surged on Monday after Powell delivered a hawkish interview on CBS’s show ’60 Minutes’ on Sunday. Powell stated that the Fed will only proceed with interest rate cuts once they see evidence that inflation is dropping sustainably. Powell reiterated his former statement that a rate cut in March is improbable and warned that the central bank will likely cut rates at a slower pace than the market expects. Policymakers will update their interest rate projections at the next meeting in March. Powell, however, emphasized that the US economy does not show signs of weakening, allowing interest rates to remain at high levels for longer.
Rate cut expectations dropped sharply after Powell’s speech but are rising again. Odds of a rate cut in March are approximately 20%, while a rate cut odds in May went up to 70% in the past couple of days. Markets are anticipating aggressive rate cuts this year, pricing in approximately five cuts, starting in May. Policymakers are trying to rein in market rate cut expectations, with limited success so far.
This week, several US policymakers are due to deliver speeches and we expect Fed rhetoric to affect the price of the dollar. FOMC members’ opinions are starting to diverge, and we may see a battle of doves against hawks at the next policy meeting. For the first time, policymakers are discussing openly the possibility of rate cuts sometime this year. Even though most FOMC members agree that they are not yet ready to start reducing interest rates, markets are interpreting the change in rhetoric as a sign that the Fed is considering a pivot to a more dovish policy.
Fed’s Loretta Mester stated on Tuesday that there is no reason to start cutting interest rates too soon. Mester, however, stated that she would be open to rate cuts later this year if inflation drops sufficiently. Coming from Mester, who is known for her hawkish stance, this statement indicates that the central bank is preparing to shift to a less restrictive monetary policy. FOMC member Neel Kashkari emphasized on Monday that the US economy’s resilience surpassed expectations, suggesting that the current level of interest rates is not having as much of an impact as expected. Kashkari was even more hawkish on Wednesday warning against cutting rates too quickly and said he only expects two or three cuts this year. Fed’s Susan Collins was also cautious, stating that she would need to see more evidence of disinflation before considering adjusting the policy stance. FOMC member Adriana Kugler stated on Wednesday that she is pleased with the disinflation progress and sees rate cuts at some point.
US fundamentals will affect the dollar strongly in the weeks to come as these are likely to influence the Fed’s future policy.
ISM Services PMI data on Monday exceeded expectations, boosting the dollar. The ISM Services PMI indicator rose to 53.4 in January, surpassing expectations of 52.0 and December’s print of 50.6. The US Services sector appears to be expanding at an accelerating pace, as a print above 50 indicates industry expansion.
Core PCE price index rose by 0.2% in December, which was in line with expectations. Core PCE price index dropped to 2.9% year-on-year in December from a 3.2% print in November. This is the Federal Reserve’s preferred inflation gauge, and a lower print indicates that price pressures in the US are easing.
Advance GDP for the final quarter of 2023 showed that the US economy expanded by 3.3% against the expectation of a more modest 2.0% growth. The US economy is expanding at a slower pace, as final GDP data have shown expansion by 4.9% in the third quarter of 2023, but economic growth in Q4 of 2023 exceeded expectations. Advance GDP Price Index for the final quarter of 2023 came in at 1.5% against expectations of 2.3% and a final print of 3.3% in the previous quarter. This is an indicator of inflation, and a lower print indicates cooling price pressures in the US.
Headline inflation rose by 3.4% year-on-year in December from a 3.1% print in November against the expectation of a 3.2% raise. Monthly CPI rose by 0.3% in December, exceeding expectations of a 0.2% print. Core CPI, which excludes food and energy, rose by 0.3%, in line with expectations. Inflation in the US remains sticky and may put pressure on the Fed to keep interest rates at high levels for longer.
EUR/USD edged higher on Wednesday, rising to the 1.077 level. If the EUR/USD pair declines, it may find support at 1.072, while resistance may be encountered near 1.089.
German Industrial Production data on Wednesday showed that Industrial Production shrank by 1.6% in December against expectations of a drop of only 0.4%. German factory orders on the other hand, unexpectedly jumped in December according to data released on Tuesday, posting their highest monthly increase in more than three years. German factory orders rose by 8.5% in December against expectations of a 0.1% drop.
German exports fell more than expected in December due to weak global demand, according to the German Trade Balance released on Monday. Germany’s overall trade balance improved in December, rising to 22.2B from 20.7B in November. German exports fell by 4.6% in December, though, against expectations of a 2.0% decrease.
The ECB kept interest rates unchanged at 4.50% as expected at its January meeting. The ECB press conference following the conclusion of the meeting did not hold many clues on the central bank’s policy direction. ECB President Christine Lagarde stated that interest rates are currently at sufficiently high levels to bring inflation down to the central bank’s 2% target over time. Lagarde also reiterated that ECB interest rates will remain at sufficiently restrictive levels for as long as necessary.
Markets are pricing in rate cuts this year, although ECB policymakers are concerned about persistent inflationary pressures in the Eurozone. The ECB is expected to pivot to a more dovish policy later this year, but the timeline is still uncertain. Markets anticipate rate cuts of around 140 bps in 2024. Odds of ECB rate cuts starting in April are rising, and markets are pricing 50bp of rate cuts by June.
Headline inflation in the EU came in at 2.8% year-on-year in January. Eurozone inflation dropped from 2.9% in December, although markets were anticipating an even lower 2.7% print. Core inflation, which excludes food and energy, cooled to 3.3% from 3.4% in December, which again was just above the 3.2% expected.
The Eurozone economy does not show sufficient signs of recovery and is on the brink of recession. Preliminary GDP data released on Tuesday for the final quarter of 2023 showed that the Euro Area economy remained stagnant, narrowly avoiding recession. The German economy shrank in the final three months of 2023. Preliminary GDP data showed that the EU’s leading economy shrank by 0.3% in Q4 of 2023.
Revised GDP for the Euro area showed that the Eurozone economy contracted by 0.1% in the third quarter of the year, which was in line with expectations. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. The Eurozone economy is struggling and cannot withstand much further tightening.
The Sterling gained strength against the dollar on Wednesday and GBP/USD rose to the 1.263 level. If the GBP/USD rate goes up, it may encounter resistance near 1.270, while support may be found near 1.250.
The Halifax index, which is a leading indicator of the housing industry's health, grew by 1.3% in January against expectations of 0.8% raise. British house prices grew by 2.5% year-on-year in January, the highest annual growth rate in a year.
British Construction PMI data were higher than anticipated, boosting the sterling. Construction PMI rose to 48.8 in January from 46.8 in December and against expectations of a 47.2 print. The British construction sector remains in contractionary territory, indicated by a print below 50, but the pace at which the sector is shrinking is slowing down.
UK Final Services PMI data released on Monday also exceeded expectations, providing support for the Sterling. Final Services PMI rose to 54.3 in January from 53.8 in December against expectations of a steady print of 53.8. The British Service sector continues to expand, with January’s print remaining firmly above the 50 threshold that denotes industry expansion.
The BOE maintained its official rate at 5.25% at its meeting last week, as expected. MPC members, however, were more divided than ever. In December’s meeting seven members had voted to keep interest rates unchanged and two had voted to increase interest rates. Last week, 6 members voted to keep rates unchanged, two voted in favor of a 25bp rate hike and one member voted in favor of a 25bp rate cut.
Markets interpreted this as a first sign that the BOE was considering a shift to a more dovish policy and the Sterling soared. In addition, the BOE updated its inflation outlook, predicting that inflation will drop to the BOE’s 2% target in the second quarter of the year. This reinforced the notion that the central bank is preparing to cut interest rates before the summer.
BOE Governor Andrew Bailey delivered a speech that was less hawkish than usual. Bailey stressed that inflationary pressures are cooling and that further rate hikes are not required. Bailey also mentioned rate cuts for the first time, stating that policymakers do not need to bring inflation down to the central bank’s 2% target to start cutting interest rates, they just need to know that the process of disinflation is progressing.
BOE Chief Economist Huw Pill was hawkish in an interview on Monday, indicating that the central bank does not intend to start reducing interest rates yet. BOE’s Sarah Breeden, however, was more dovish on Wednesday, stating that she doesn’t think the question is whether to raise interest rates further, but rather when to start cutting interest rates.
Headline inflation rose to 4.0% year-on-year in December from 3.9% in November, against expectations of a 3.8% print. This marked the first rise in consumer inflation in 10 months, increasing the odds the BOE will keep interest rates at high levels for longer. Annual Core CPI, which excludes food and energy, grew at the same pace of 5.1% in December as in November, beating the 4.9% forecast.
The British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Monthly GDP rose more than expected in November, however, inspiring more optimism on the UK’s economic outlook. The British economy expanded by 0.3% in November against expectations of a 0.2% growth and 0.3% contraction in October. Final quarterly GDP data revealed that the British economy contracted by 0.1% in the third quarter of 2023, against expectations of stagnation. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter.
USD/JPY traded sideways on Wednesday, oscillating around the 148.1 level. If the USD/JPY pair declines, it may find support near 146. If the pair climbs, it may find resistance near 148.8.
Average Cash Earnings in Japan rose by 1.0% year-on-year in December according to data released on Tuesday against expectations of 1.3% growth. Earnings data adjusted for inflation, however, showed that Japanese workers’ real wages fell for the 21st straight month in December. Low wages pose a concern for the BOJ as they may drag inflation down.
The BOJ kept all policy levers unchanged at its January meeting, maintaining its ultra-easy monetary policy. The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. The BOJ has so far maintained its dovish bias as other major central banks, especially the Fed, have raised interest rates to high levels.
BOJ Governor Kazuo Ueda has hinted at a policy shift down the road. Ueda stated that the likelihood of Japan sustainably achieving the bank's 2% inflation target was gradually increasing. Ueda’s comments increased market odds of a hawkish pivot later in the year.
According to the BOJ Summary of Opinions, which outlines policymakers’ opinions expressed at the latest policy meeting, BOJ officials discussed the end of the central bank’s ultra-easy policy at the BOJ’s latest meeting. The possibility of ending negative interest rates was discussed at the policy meeting, indicating that the BOJ is preparing to pivot to a more hawkish policy shortly.
An immediate policy shift is not expected yet, but markets are pricing in the first BOJ rate hike in April with over 50% probability. A rate hike by June is considered almost certain, with market odds giving over 90% probability of a shift in the BOJ’s monetary policy by June. Only a small rate hike of 10bps is considered likely, which would bring the BOJ’s interest level from negative to zero.
Inflationary pressures are not sufficiently high in Japan to justify a shift to a more hawkish policy yet. National Core CPI data showed that Japanese inflation cooled further in December with headline inflation at 2.3% year-on-year from a 2.5% print in November. Tokyo Core CPI also dropped to 1.6% in January from 2.1% in December.
Final GDP data for the third quarter of the year showed that Japan's economy contracted by 0.5% in the third quarter against earlier estimates of a 0.5% contraction. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking and is on the brink of recession. Final GDP Price Index showed a 5.3% annual expansion in Q2, versus 3.5% the previous quarter. This is a measure of inflation, which shows that inflationary pressures are rising in Japan, increasing the odds of a hawkish shift in the BOJ’s policy.
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Written by:
Myrsini Giannouli
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