Important calendar events
The dollar rallied slightly on Thursday, after crashing on Wednesday. The dollar index climbed from 100.8 to 101.6, as markets had time to digest the Fed’s interest rate decision. US Treasury yields remained under pressure, with the US 10-year bond yielding below 3.40%.
Fed interest rate changes have been the main factor driving the US dollar and treasury yields over the past few months. After a series of aggressive rate hikes last year, the Fed has finally decided to relax its hawkish policy. The Federal Reserve raised interest rates by only 25 basis points in Wednesday’s meeting, bringing the benchmark interest rate to a target range of 4.50% to 4.75%. A pivot towards a more dovish policy was expected by markets, however, and had been largely priced in. Nevertheless, the initial market response was negative for the dollar, and the currency plummeted.
Fed Chair Jerome Powell, at his press conference after the conclusion of the meeting defended the central bank’s decision to relax its hawkish policy. Powell expressed himself as satisfied with the ‘disinflation’ process. Powell emphasized, however, that ongoing rate hikes are appropriate since substantial evidence is necessary that inflation is under control.
Many analysts believe that the Fed will continue raising interest rates at a slower pace until the benchmark interest rate reaches at least 5.0%. This means that there are likely still a couple of rate hikes up ahead, which may provide support for the dollar.
US inflation seems to be cooling, as US headline inflation also dropped to 6.5% year-on-year in December from 7.1% in November. Cooling price pressures have given the US Federal Reserve some leeway towards scaling back its interest rate increases, putting pressure on the dollar.
Advanced quarterly GDP data revealed that the US economy is expanding at a higher rate than anticipated. US GDP for Q4 of 2022 grew by 2.9% against expectations of a 2.6% growth. The US is likely headed for an economic ‘soft landing’ and recession concerns ease.
Several economic activities and health indicators are scheduled to be released on Friday for the US including Average Hourly Earnings, Non-Farm Employment Change, Unemployment Rate, Final Services PMI, and ISM Services PMI, and may affect the dollar in the wake of Wednesday’s Fed rate decision.
The Euro plummeted on Thursday after the ECB monetary policy meeting, with EUR/USD dropping to 1.090. If the currency pair goes up, it may encounter resistance near 1.118. If the EUR/USD pair declines, it may find support at 1.076.
The ECB meeting raised interest rates by another 50 bp in its policy meeting on Thursday, bringing its main refinancing rate to 3.0%. The rate hike was in line with market expectations though and had already been priced in. On the other hand, the Fed has started to pivot towards a more dovish policy, voting for a 25-bp rate hike on Wednesday.
After the conclusion of the meeting, ECB President Christine Lagarde gave a press conference with hawkish undertones. Lagarde emphasized that the central bank aims to bring inflation down to 2%. Lagarde confirmed that another 50-bp rate hike would follow at the next monetary policy meeting in March, after which the ECB would re-evaluate its policy. Even though the ECB seems prepared to continue raising interest rates to bring inflation down, the initial market response was negative for the Euro, which plummeted.
EU inflation rates are decreasing, but they are still far from the ECB’s 2% goal and are forcing the central bank to hike rates aggressively. Eurozone headline inflation dropped sharply in January according to CPI data released on Wednesday. Final EU headline inflation dropped to 8.5% year-on-year in January from a 9.2% print in December, indicating that Eurozone inflation is cooling. The continued drop in inflation signals that the ECB’s efforts to tame inflation are bearing fruit.
Reduced fuel costs are one of the main reasons for the sudden drop in inflation. Core CPI, which excludes food and energy, remained steady in January at 5.2% on an annual basis. Price pressures in the Eurozone remain high though, and interest rates need to rise significantly to combat entrenched inflation.
Several economic activity indicators are scheduled to be released on Friday for the Eurozone, such as French Industrial Production, Spanish, Italian, French, and German Services PMI, and Eurozone Final Services PMI.
The Sterling plummeted on Thursday after the BOE showed signs of pivoting toward a more dovish direction. The initial market response to the outcome of the meeting was negative for the Sterling and GBP/USD continued to drop below the 1.226 level support. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.208.
The BOE raised interest rates by another 50-bp rate hike in Thursday’s meeting, bringing the official bank rate to 4.0%. Seven out of nine MPC members voted in favor of the rate hike, while the other two voted to keep interest rates unchanged. The rate hike fell in line with market expectations and had already been priced in. On the other hand, the Fed proved to be less aggressive in its tightening regime on Wednesday, voting for a 25-bp increase.
The BOE Monetary Policy Report issued after the meeting, however, was more dovish than expected, pulling the Sterling down. MPC members appeared to be optimistic about the UK’s inflation trajectory, pointing to a pause in rate hikes shortly. The policy report stated that “if there are more persistent price pressures then only will further tightening be required”.
Inflation data have shown that inflation in the UK is cooling. PPI Input dropped by 0.2% in November from an increase of 0.9% in October, and in December, consumer inflation cooled even further, decreasing by 1.1%. Similarly, PPI output data released for November and December showed that British manufacturers unexpectedly lowered their prices in the past two months, suggesting that inflation may be easing. In addition, UK headline inflation dropped to 10.5% in December from 10.7% in November. With inflation remaining firmly above 10% though, additional measures would be required to bring price pressures down.
The UK’s grim economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The IMF downgraded the UK’s growth forecast, predicting that the British economy will contract by 0.6% this year. The final GDP print for the third quarter of 2022 was -0.3%, indicating that the economy in the UK is shrinking. The British economy is still struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down.
UK Final Services PMI data are due on Friday and may affect Sterling's price in the wake of Thursday’s BOE meeting.
The Yen gained strength against the dollar after the Fed meeting on Wednesday and remained strong on Thursday, with USD/JPY trading sideways around the 128.7 level. If the USD/JPY pair declines, it may find support near 127.2 and further down at 114.2. If the pair climbs, it may find resistance at 131.6.
Annual Monetary Base data were released on Thursday for Japan. The data represents the change in the total quantity of domestic currency in circulation and current account deposits held at the BOJ. Monetary base data in January contracted by 3.8% against expectations of a 3.2% decrease, indicating worsening economic conditions.
Japanese policymakers maintained ultra-low interest rates at the BOJ’s January meeting, keeping the central bank’s refinancing rate at -0.10% as expected. BOJ Governor Haruhiko Kuroda defended the central bank's decision to keep its yield curve control policy unchanged and vowed to conduct unlimited bond buying to maintain the bank’s yield curve control. Kuroda, however, is due to retire in April and his successor may decide to unwind the BOJ’s ultra-easy policy. A pivot in Japan’s monetary policy within 2023, would boost the Yen considerably.
The BOJ caused a stir in markets in its previous meeting in December by changing its yield control target for the 10-year government bond to between plus or minus 0.50%, from a previous 0.25%. The BOJ had set a target range around zero for government bond yields for years, and this adjustment may be the signal of a shift towards a more hawkish policy. Long-term, this move may allow interest rates to rise, cutting off some of its monetary stimuli.
BOJ Core CPI rose to 3.1% year-on-year, exceeding expectations of a 2.9% print. Inflation in Japan has gone above the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households. National Core CPI for December was at 4.0%, rising above November’s 3.7% print.
The final GDP Price Index for the third quarter of 2022 showed economic contraction by 0.3% on an annual basis and the Japanese economy shrank by 0.2% in the third quarter of 2022, mainly due to the high costs of imported energy. Japan’s economic outlook is poor, raising recession concerns for the world’s third-biggest economy.
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