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Dollar boosted by hawkish Fed statements

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Written by:
Myrsini Giannouli

22 March 2022
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Ukraine crisis update

 

War continues raging in Ukraine, with heavy casualties including civilians and children. Mariupol has been under a brutal siege and Russia has demanded the surrender of the besieged city, with Ukraine refusing and the Ukrainian military fighting hard to save the city from Russian occupation. Millions of refugees are fleeing Ukraine, creating an additional issue for the EU, which has vowed to accept all refugees entering its borders from Ukraine. 

Diplomatic talks between Russia and Ukraine this week have sparked hopes of a de-escalation of the conflict, although Russian attacks continue. Diplomatic negotiations have entered a more serious phase, as both sides seem to acknowledge there is room for compromise and for finding a middle ground. On Sunday, Turkish foreign minister Mevlut Cavusoglu said that the two sides are “close to an agreement”, although this opinion has not been confirmed by another one of the warring sides. 

The ECB, the Fed, and other major Central Banks are trying to strike a balance between soaring inflation rates and economic woes since the onset of the pandemic, and the war in Ukraine is complicating matters further. Sanctions against Russia are driving the price of key commodities up, especially energy-related commodities, further increasing inflation.

Stock markets have been plummeting amid a rapid increase in the price of commodities and concerns about further military escalations. Fears that sanctions against Russia would have a severe impact on the global economy have been pushing markets down. The Rouble has plummeted to historic lows, while the Russian Stock Exchange remained closed for weeks, but reopened on Monday. Russia had trouble making its sovereign debt payments last week, with the Russian finance minister stating that Russia would make the payments in roubles rather than dollars. A national default was feared, which would be the country’s first default since 1998, but it was averted and it seems that Russia will meet its debt obligations. The Rouble gained a little ground last week as there were hopes that the crisis in Ukraine might be diffused, but lost its gains later in the week after the Russian Central Bank decided to keep its interest rate to 20%. 

Important Calendar Events

  • EUR: Current Account, ECB President Lagarde speech
  • GBP: Public Sector Net Borrowing, CBI Industrial Order Expectations, MPC Member Cunliffe Speech
  • USD: Richmond Manufacturing Index, FOMC Member Williams Speech

USD

The dollar index climbed above 98.5 on Monday, after Fed Chair Jerome Powell pointed to a more aggressive monetary policy. Powell delivered a speech at the NABE economic policy conference on Monday, speaking after Atlanta Fed President Raphael Bostic. Both FOMC member speeches were considered hawkish, advocating for a tighter fiscal policy. Powel stated that the Fed must move "expeditiously" to bring inflation under control and his speech boosted the dollar.

The dollar had dropped last week in the wake of the Federal Reserve's latest policy meeting, at which the Federal Reserve raised its benchmark interest rate by 25 base points, bringing its interest rate to 0.50%. In the ensuing press conference, Federal Reserve Chairman Jerome Powell signaled that the Fed’s interest rates could reach nearly 2% by the end of the year, pointing to six rate hikes within the year. The US Central bank is attempting to bring down inflation that has been rising at the fastest rate in 40 years. Fed officials have also raised inflation forecasts for 2022 to 4.3%, in a move that has been interpreted as hawkish. The 25-base point rate hike though was widely expected and had already been priced in by markets. Some investors were even expecting a steeper rate hike and the more conservative interest raise pushed the dollar down. Markets are anticipating total rate hikes of 175 base points within the year to tackle soaring inflation rates.

Diplomatic negotiations between Russia and Ukraine continue and hopes of de-escalation of the crisis have been driving the dollar down. The dollar is considered a safe-haven currency and rises when a risk-aversion sentiment prevails, as investors turn towards safer assets. The recent efforts to defuse the crisis have added pressure to the price of the dollar, although its price remains high as the crisis continues.

Minor economic events are scheduled on Tuesday for the dollar, such as the Richmond Manufacturing Index and FOMC Member Williams's speech. FOMC members' speeches will be scanned by investors who seek to gain insight into the Fed’s future monetary policy.

TRADE USD PAIRS

EUR 

The EUR/USD rate fell to 1.101, as the Euro weakened against the dollar. If the currency pair goes up, it may encounter resistance at 1.148 and further up at 1.169, while if it declines, support may be found at the 1.063 level. 

ECB President Christine Lagarde delivered a speech at the Institute Montaigne in Paris on Monday, stating that inflation is expected to rise in the Eurozone, but will drop again in the long run. Lagarde further pointed out that ECB monetary policies will not be in sync with the Fed policy, reiterating the ECB’s commitment to a more dovish policy than other central banks. Last week, Christine Lagarde stressed that the ECB needs to remain flexible and may alter its monetary policy in response to unforeseen inflationary pressures arising from the war in Ukraine, but stated that the EU Central Bank is in no hurry to raise its interest rate. 

On Monday, the German PPI index, which is a key indicator of consumer inflation for the Eurozone’s leading economy, was released and was lower than expected. Inflation rates are expected to increase significantly in the following months though, caused by commodity and energy price increases due to the war in Ukraine.

The ECB has been pursuing a more cautious fiscal policy than other major Central Banks, although it has recently turned towards a more hawkish direction. The ECB has recently announced its decision to wind down its bond-purchasing program sooner than expected, placing the end of the bond-buying program at the third quarter of 2022, if financial conditions in the Eurozone allow it. The ECB is trying to avert a dangerous economic effect known as stagflation, the mix of economic stagnation and high inflation rates. 

In addition, the European Central Bank has announced that it does not plan to raise its benchmark interest rate before the end of its bond-buying program in the third quarter of 2022. Many market analysts predict that the ECB will raise its interest rate by at least 30 base points at Q4 of 2022 and some predict a steeper rate hike of 50 bps, although so far, the ECB has been reluctant to move towards a rate hike. As the Fed and the BOE have already raised their benchmark interest rates, the Euro remains at a disadvantage from the difference in interest rates.

Minor financial indicators scheduled to be released on Tuesday for the Euro include the Eurozone Current Account, although this is not expected to affect the Euro considerably. In addition, ECB President Christine Lagarde is due to deliver a speech at the Bank for International Settlements Innovation Summit and her speech will be scanned by traders for hints into the ECB’s future policy.

EURUSD 1hr chart

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GBP 

The GBP/USD traded sideways on Monday, around the 1.316 level. If the GBP/USD rate goes up, there may be resistance at the 1.364 level, while if it declines, support may be found near the 1.299 level. 

The sterling declined last week after the latest Bank of England policy meeting on Thursday, in which the BOE announced that it would raise its benchmark interest rate by 25 base points. This is the third back-to-back rate hike for the BOE, bringing its interest rate to 0.75%. The Bank of England is shifting to a more hawkish policy and a return to pre-pandemic interest rates this year in an attempt to tackle inflation. The BOE emphasized the role of the war in Ukraine in rising inflation rates that are driving its turn to a tighter fiscal policy. The BOE’s raise of its benchmark interest rate was highly anticipated and had already been priced in by markets. Even though the BOE raised its interest rate and is tightening its monetary policy, the UK Central Bank’s overall statement was perceived as dovish and the sterling collapsed following its release. 

UK inflation is already at a 30-year high and expected to rise further, as the war in Ukraine raises the price of key commodities and energy. Rising commodity prices and import costs in the UK, and especially the high costs of imported energy, are driving inflation rates even higher. Inflationary pressures are expected to culminate in April and the BOE has upped its forecast for inflation to a 7.25% peak in April, against a backdrop of strong growth and a robust labor market in the U.K., showing that most economic sectors have returned to pre-pandemic levels. Many analysts predict though that inflation will rise above 8% this year, adding pressure to the BOE to up its interest rates even further. A tighter fiscal policy and consecutive rate hikes though may stifle the country’s economy, forcing the BOE to perform a balancing act between bringing inflation under control and allowing for economic growth.

The sterling has been under pressure since the war between Russia and Ukraine broke out and investors turned towards safer assets. The past week, however, diplomatic negotiations between Russia and Ukraine are sparking hopes of a de-escalation of the crisis and are easing some of the pressure on the currency.

Scheduled financial events for the sterling on Tuesday, including Public Sector Net Borrowing, CBI Industrial Order Expectations, and MPC Member Cunliffe Speech. Speeches by MPC members may provide some pointers as to the BOE’s future direction and can cause some volatility for the sterling.

Later in the week, the release of key indicators of inflation may cause some volatility for the pound, especially coming after the BOE policy statement last week, which cited high inflation as the main reason for the increase in the BOE’s benchmark interest rate. Inflation data is expected to exceed current estimates, and investors predict inflation will rise to 5.9%, as the spike in oil prices will start catching up with inflation.

GBPUSD 1hr chart

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JPY 

The USD/JPY rate climbed to the 119.5 level on Monday, breaking through the 118.5 level resistance, as the Yen retreated against the dollar. The USD/JPY is currently trading in an uptrend and is at its highest level since 2016. If the USD/JPY declines, support might be found at 114.8 and further down at 113.4.

In its monetary policy meeting last week, the Bank of Japan maintained its ultra-accommodating monetary policy, with unlimited bond purchases. The BOJ also did not raise its negative interest rate from -0.10%, with Bank of Japan Governor Haruhiko Kuroda stating that there is no need for Japan to raise interest rates at all. 

The BOJ’s meeting came after the Fed and BOE meetings, in which the two major Central Banks raised their benchmark interest rates. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage and, if the BOJ continues its dovish policy, it may drive the Yen further down.

Low inflation rates in Japan and a weakening economy are steering the BOJ towards maintaining its dovish monetary policy. Inflation in Japan is far below the BOJ’s 2% goal, although as prices of imported goods and energy continue to increase, inflation may rise, while overall economic health declines. Japan’s core CPI may climb around 2% in April, similar to other countries that are expected to see a peak in inflation rates at the same time, largely due to increased oil prices. Japan is a net energy importer and the current energy crisis is damaging the country’s terms of trade and overall economic health. 

Rising hopes of a resolution to the Ukraine crisis are also putting pressure on the Yen. The Yen is considered a safe-haven currency and is supported by the war in Ukraine. The Yen, however, has not picked up pace as much as other safe-haven assets, as the BOJ’s fiscal policy is keeping the currency down. 

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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