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Dollar advances as markets digest inflation data

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Written by:
Myrsini Giannouli

24 January 2023
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Important calendar events

  • Flash Manufacturing PMI, BOJ Core CPI
  • French and German Flash Services PMI, French and German Flash Manufacturing PMI, Eurozone Flash Services PMI, Eurozone Flash Manufacturing PMI
  • UK Flash Services PMI, UK Flash Manufacturing PMI
  • US Flash Services PMI, US Flash Manufacturing PMI, Richmond Manufacturing Index

USD

The dollar slipped in early trading on Monday, but advanced later on, as markets had time to digest last week’s US inflation data. The dollar index dropped to 101.6 early in the day, then rose, climbing above 102. US Treasury yields also rallied on Monday, with the US 10-year bond yielding approximately 3.52%. 

US CB Leading Index fell below expectations on Monday, putting pressure on the dollar, declining by 1.0% in December, versus the 0.7% drop expected. This is a composite index based on 10 economic indicators, and a negative print shows a worsening economic outlook.

US inflation seems to be cooling, as Producer Price Index declined by 0.5% in December, versus estimates of a 0.1% drop. In addition, November’s PPI print was revised to reflect a 0.2% increase, instead of the original 0.3% to 0.2%.

US headline inflation also dropped to 6.5% year-on-year in December from 7.1% in November. Cooling price pressures may give the US Federal Reserve some leeway towards scaling back its interest rate increases, putting pressure on the dollar. 

Fed interest rate increases have been the main factor driving the US dollar and treasury yields over the past few months. At the latest monetary policy meeting the Fed raised interest rates by 50 basis points, bringing the benchmark interest rate to a target range of 4.25% to 4.50%. 

US economic outlook and inflation will likely determine the pace of future rate hikes. Many analysts believe that the Fed will ease its rate hikes but 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. Markets however are currently pricing in a more moderate 25-bp rate hike at the Fed’s next monetary policy meeting.

US Flash Services PMI and US Flash Manufacturing PMI are scheduled to be released on Tuesday and may cause volatility in dollar prices. As interest in the Fed’s future policy direction mounts, the dollar will also be especially sensitive to FOMC members’ speeches this week.

TRADE USD PAIRS

EUR 

The Euro touched a nine-month high against the dollar in early trading on Monday but pared gains later in the day. EUR/USD climbed to 1.092 early in the day but dropped below 1.085 later. If the currency pair goes up, it may encounter resistance at 1.089 and higher up near 1.118. If the EUR/USD pair declines, it may find support at 1.048. 

On Monday, ECB President Christine Lagarde delivered a particularly hawkish speech, providing support for the Euro. Lagarde stated that the ECB will still have to raise interest rates significantly at a steady pace to combat soaring inflation.

Last week, Lagarde’s hawkish stance at the World Economic Forum in Davos bolstered the Euro. Lagarde emphasized the central bank’s commitment to raising interest rates. Lagarde stressed that the ECB will stay the course with rate hikes to tackle soaring inflation. Lagarde also warned that China’s reopening would add to global inflationary pressures. Dutch central bank chief Klass Knot also speaking at DAVOS, stated that markets should expect multiple 50-bp rate hikes this year.

Final EU headline inflation dropped to 9.2% year-on-year in December from a 10.1% print in November indicating that Eurozone inflation is cooling. This is the first drastic drop in inflation that signals that the ECB’s efforts to tame inflation are bearing fruit. Price pressures in the Eurozone remain high though, and interest rates need to rise significantly to combat entrenched inflation. 

EU inflation rates are still far from the ECB’s 2% goal and are forcing the central bank to hike rates aggressively. In its latest monetary policy meeting in December, the ECB raised interest rates by 50 bp, bringing its benchmark interest rate to 2.50%. 

The question, however, is whether economic conditions in the Eurozone will allow the ECB to continue raising interest rates at a fast pace. EU economic outlook is poor, and the ECB might be forced to raise interest rates in a recessionary backdrop.

Markets are pricing in at least two more 50-bp rate hikes in February and March this year. On the other hand, market odds for the next Fed rate hike are at 25-bp, as a pivot in the Fed’s policy is expected. If this scenario comes true, it will boost the Euro against the dollar. 

Eurozone Flash Services PMI and Manufacturing PMI are scheduled to be released on Tuesday and may cause volatility in Euro price. Market participants will also pay close attention to ECB members’ speeches to gauge the central bank’s monetary policy direction.

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

The Sterling gained strength early on Monday, climbing to a seven-month high against the dollar. GBP/USD climbed to 1.244 but dropped to 1.235 later in the day as the dollar rallied. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.184. 

BOE Governor Andrew Bailey last week appeared to be optimistic about British inflation this year, stating that that inflation looks set to fall markedly as energy prices decrease. He stressed, however, that labor shortages in the UK pose a threat to cooling inflation rates. Bailey also stated that a corner has been turned in UK inflation, appearing confident that inflation rates will continue to decline.

UK headline inflation dropped to 10.5% in December from 10.7% in November, in line with expectations. Core CPI, which excludes food and energy, remained at 6.3%, against expectations of a 6.2% print. The Sterling went up after the release of the CPI data as UK inflation has become entrenched, remaining firmly above 10%.

Surging inflation has forced the BOE to adopt a more hawkish fiscal policy, bringing its interest rate to 3.50% in December, its highest rate in 14 years. In the latest monetary policy meeting in December, BOE members voted to hike rates by 50 bps. With inflation remaining above 10%, this was perceived by many analysts as the start of a pivot toward a more dovish fiscal policy, putting pressure on the Sterling. 

The UK’s grim economic outlook may limit policymakers’ ability to increase interest rates sufficiently to rein in inflation. 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 Flash Services PMI and Manufacturing PMI data on Tuesday may affect the Sterling. BOE rhetoric is also expected to influence Sterling's price.

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen retreated on Monday, weighed down by the BOJ’s persistently dovish policy, after the BOJ disappointed market expectations last week. USD/JPY extended gains on Monday, reaching 130.8. 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 138.2.

Monetary Policy Meeting Minutes of the BOJ’s previous meeting in December was released on Monday. The meetings showed that Government Officials attending the meeting sought a half-hour adjournment during the meeting to contact their ministries, before reaching a crucial decision on the central bank’s yield curve control policy.

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.

Japanese policymakers maintained ultra-low interest rates last week, keeping the central bank’s refinancing rate at -0.10% as expected. The BOJ was expected to relax its yield curve control policy further, but the central bank left all policy settings unchanged this month putting pressure on the Yen.

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. 

Price pressures continue to rise in Japan, as Year-on-year PPI to the end of December came in at 10.2% on Monday, exceeding expectations of a 9.5% print. National Core CPI for December released on Friday was at 4.0%, rising above November’s 3.7% print. In addition, BOJ CPI recently rose to 2.9%, mainly due to the high cost of imported energy. Inflation in Japan has gone above the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households.

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.

Flash Manufacturing PMI and BOJ Core CPI data are scheduled to be released on Tuesday for Japan and may cause some volatility in the price of the Yen.

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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