Yen reaches yearly high after BOJ decision

Important calendar events

• JPY: Final Manufacturing PMI
• GBP: Final Manufacturing PMI
• USD: ADP Non-Farm Employment Change, Final Manufacturing PMI, ISM Manufacturing PMI, JOLTS Job Openings, ISM Manufacturing Prices, Federal Funds Rate, FOMC Statement, FOMC Press Conference

USD

The dollar surged on Tuesday, ahead of Wednesday’s Fed rate decision, with the dollar index climbing to the 106.7 level. US bond yields also rallied, with the US 10-year bond yielding approximately 4.93%. 

This week all eyes are going to be on the Fed monetary policy meeting on November 1st. FOMC members voted to keep interest rates unchanged at a target range of 5.25% to 5.50%. at September’s policy meeting. 

Markets widely expect the Fed to hold rates steady this week, after FOMC members’ dovish comments in the past couple of weeks. Fed Chair Jerome Powell’s speech after the conclusion of the meeting is going to attract the attention of traders. A pause in rate hikes this week is almost considered a given and has already been priced in, and market participants will focus mostly on the Fed’s forward guidance.

Markets anticipate that Fed rates will remain the same this year, with an approximately 95% probability of a pause at this week’s meeting and a more than 70% probability of an end to rate hikes through 2023. The probability of another rate hike within the year has decreased. Still, the possibility of another increase in interest rates cannot be completely discounted and is likely to affect the dollar in the coming weeks. The Fed may decide to pause rate hikes completely, but interest rates are likely to remain in restrictive territory for longer.

Upbeat economic activity data boosted the dollar on Tuesday. CB Consumer Confidence exceeded expectations with a print of 102.6 in October, which was nevertheless lower than September’s revised 104.3 print. Employment Cost Index, which reflects the change in the price businesses and the government pay for civilian labor, rose by 1.1% in the third quarter of the year, beating estimates of a 1.0% growth. 

The US economy seems to be recovering, boosting the dollar. Advance GDP data for the third quarter of 2023 showed that the US economy expanded by 4.9%, against expectations of 4.5% growth and far surpassing the 2.1% growth of Q2. Advance GDP price index for the 3rd quarter of the year reached 3.5%, exceeding expectations of a 2.7% print. 

Core PCE Price Index, which is the Fed’s preferred inflation gauge, rose by 0.3% in September, in line with expectations. Core PCE Price Index dropped to 3.7% year-on-year in September from a 3.8% print the previous month. Inflationary pressures in the US are easing, reinforcing the notion that the Federal Reserve will not have to raise interest rates further. US headline inflation in September, however, remained at August's levels of 3.7% year-on-year, while market analysts were expecting a drop to 3.6%. 

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EUR 

The EUR/USD rate was mainly directed by the dollar’s movement on Tuesday, surging to the 1.067 level in early trading on a weaker dollar, then plummeting to 1.056 as the dollar gained strength. If the EUR/USD pair declines, it may find support at 1.052, while resistance may be encountered near 1.069. 

On the data front, the economic outlook of the Eurozone appears to be deteriorating, putting pressure on the Euro. Preliminary GDP data for the Euro area showed that the Eurozone economy contracted by 0.1% in the third quarter of the year against expectations of stagnation. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. The EU economy is struggling and cannot withstand much further tightening. 

Headline inflation in the Eurozone fell to its lowest level in two years in October, mainly due to a drop in energy prices. Flash CPI cooled to 2.9% year-on-year in October from 4.3% in September against expectations of a 3.1% print. Core CPI Flash Estimate, which excludes food and energy, was in line with expectations. Core CPI eased to 4.2% year-on-year in October from 4.5% in September. The ECB’s efforts to curb inflation rates are paying off, even at the cost of decreased economic growth.

The ECB policy rate announcement last week held few surprises. The ECB decided to keep interest rates unchanged at 4.50%. The pause in rate hikes was widely expected and market reaction was somewhat muted. The Euro dipped even further after the rate announcement, as markets expect that the ECB has hit its rate ceiling, putting pressure on the Euro. 

The ECB is tasked with assessing the risk to the fragile Eurozone economy against high inflation rates. In its monetary policy statement, the ECB indicated that inflation will likely remain high for a long time. The central bank, however, stressed that interest rates have already been raised to high levels, and will continue to be transmitted into financing conditions.

ECB President Christine Lagarde, speaking at the end of the monetary policy meeting has hinted at an end to rate hikes. Lagarde highlighted the risks to the Eurozone economy stressing that the economy is likely to remain weak for the remainder of the year. Lagarde also stated that it is too early to talk about rate cuts and warned that interest rates will remain at sufficiently restrictive levels for as long as necessary.

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GBP

GBP/USD was affected by the dollar’s volatility on Tuesday, rising to 1.219 in early trading as the dollar weakened, then paring gains and dropping to 1.212 as the dollar recovered. If the GBP/USD rate goes up, it may encounter resistance near 1.228, while support may be found near 1.206. 

The BOE will announce its official rate at the end of its monetary policy meeting this week on November 2nd, a day after the Fed interest rate announcement. The BOE maintained its official rate at 5.25% at its policy meeting in September against expectations of a 25-bp rate hike. The BOE has also signaled that it has likely reached its peak interest rate. 

Market analysts are predicting that the BOE will hold interest rates steady this month. Traders will focus mainly on the Monetary Policy Summary, as well as on BOE Governor Andrew Bailey’s speech after the meeting. The BOE has likely reached its rate ceiling but will keep interest rates on hold for a long time to bring inflation down.

Recent fundamentals have shown that the British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Prolonged tightening has taken its toll on the labor market and other vital economic sectors.

The British economy continues to struggle, registering only nominal growth. GDP data revealed that Britain’s economy only partially recovered in August after a sharp drop in July. The British economy expanded by 0.2% in August from a 0.6% contraction in July, in line with expectations. 

Quarterly GDP data have shown that the British economy expanded at a higher pace than anticipated, expanding by 0.3% in the first three months of the year. GDP data for the second quarter of the year indicated a 0.2% expansion. More importantly, the UK's economy has grown by 1.8% since the pandemic started, beating the previous estimate of a 0.2% contraction.

BOE Governor Andrew Bailey has stated that the central bank will be watching closely to see if further rate hikes are needed. Bailey has also emphasized that the BOE will be holding interest rates in restrictive territory long enough to see inflation down to the bank’s 2% target.

British Inflation is not cooling down fast enough, despite the BOE’s consistently hawkish policy. Headline inflation remained at 6.7% year-on-year in September, the same as in August, against expectations of a drop to 6.6%. 

A combination of a struggling economy and high inflation is making the BOE’s task more difficult. Further tightening is needed to bring inflation down at the risk of tipping the British economy into recession. 

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JPY

The Yen plummeted on Tuesday after the BOJ monetary policy meeting. The USD/JPY rate skyrocketed to the 151.7 level, its highest value since October 2022. If the USD/JPY pair declines, it may find support near 149.3. If the pair climbs, it may find resistance at 151.9.

On Tuesday, the BOJ maintained its short-term interest rate target steady at -0.10% and that for the 10-year government bond yield around 0% set under its yield curve control, but redefined the 1.0% limit as a less restrictive ceiling rather than a rigid cap. Even though the BOJ tweaked its yield curve control policy slightly on Tuesday, markets were expecting a bigger shift in policy, and the Yen plummeted after the interest rate announcement. 

The BOJ has so far maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have raised interest rates to high levels. BOJ Governor Kazuo Ueda had lately hinted that the Central Bank may finally pivot to a more restrictive policy but has so far failed to meet market expectations. Tuesday’s slight tweak in yield curve control was interpreted by markets as “too little, too late” and failed to appease investors. 

Japanese authorities have been repeatedly warning speculators against excessive short selling of the Yen and have stepped in several times in the past year to provide support for the Yen. Market participants were concerned that another intervention may bring the currency rate down forcibly and were hesitant to bid excessively against the Yen. On Tuesday, however, the Japanese Ministry of Finance finally admitted that it was not involved in the Yen’s recent surges, which were probably the result of trading algorithms. The news that the Japanese government did not move to support the Yen a few weeks ago made traders bolder on Tuesday, and the Yen collapsed to a yearly low.

National Core CPI dropped to 2.8% in September from 3.3% in August. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. 

Final GDP data for the second quarter of the year showed that the Japanese economy expanded by 1.2%, disappointing expectations of 1.4% growth. The final GDP Price Index showed a 3.5% annual expansion, versus 3.4% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

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Written by:
Myrsini Giannouli

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