Important calendar events
The dollar rallied at the end of last week and continued to ascend on Monday, as markets had time to digest the Fed’s interest rate decision, with the dollar index rising to 103.5. US Treasury yields also strengthened on Monday, with the US 10-year bond rising to 3.63%.
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 last week, bringing the benchmark interest rate to a target range of 4.50% to 4.75%. However, a pivot towards a more dovish policy was expected by markets and had been largely priced in.
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 caused a stir in markets, expressing himself as satisfied with the ‘disinflation’ process. Powell emphasized that ongoing rate hikes are appropriate since substantial evidence is necessary that inflation is under control.
Market response to last week’s Fed rate meeting was delayed. The initial market response was negative for the dollar, and the currency plummeted. In the past few days, markets began to weigh in on the implications of the Fed’s decisions and the dollar rebounded.
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 there are likely still a couple of rate hikes up ahead, which may support the dollar. Rate hikes have become less aggressive, but the Fed might continue raising interest rates for longer than expected.
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.
Minor fundamentals are due on Tuesday for the US, including, Trade Balance, IBD/TIPP Economic Optimism, and Consumer Credit.
This week, the dollar’s direction is expected to depend largely on Fed rhetoric. Fed Chair Powell’s speech on Tuesday is one of the week's most important events. Traders will follow his speech closely, looking out for hints on the central bank’s future policy.
The Euro plummeted last week after the ECB monetary policy meeting. EUR/USD extended losses on Monday, dropping below the 1.076 level support, touching 1.072. If the currency pair goes up, it may encounter resistance near 1.103. If the EUR/USD pair declines, it may find support at 1.048.
Eurozone fundamentals released on Monday were overall mixed. German Factory Orders climbed to 3.2% in December against expectations of a 2.2% raise. Sentix Investor Confidence in February remained at negative levels with a -8.0 print, which was nonetheless higher than last month’s -17.5 print. Eurozone retail sales for December were disappointing though, declining by 2.7% against a 1.2% growth in November.
The ECB meeting raised interest rates by another 50 bp last week, bringing its main refinancing rate to 3.0%. The rate hike was in line with market expectations though and had already been priced in.
ECB President Christine Lagarde gave a press conference with hawkish undertones after last week’s ECB meeting. Lagarde emphasized that the central bank aims to bring inflation down to its 2% target. 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. Market odds are currently favoring an increase of the ECB refinancing rate to 4.0% by June. Even though the ECB seems prepared to continue raising interest rates to bring inflation down, the market response was negative towards 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. Final EU headline inflation dropped 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. Price pressures in the Eurozone remain high though, and interest rates need to rise significantly to combat entrenched inflation.
The Sterling plummeted last week after the BOE showed signs of pivoting toward a more dovish direction. The market response to the outcome of the meeting was negative for the Sterling and GBP/USD extended losses on Monday, touching 1.200. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while further support may be found near 1.284.
The BOE raised interest rates by another 50-bp rate hike last week, bringing the official bank rate to 4.0%. The rate hike fell in line with market expectations and had already been priced in.
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 possible pause in rate hikes. 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. 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.
BRC Retail Sales Monitor and Halifax HPI are scheduled to be released on Tuesday but are not expected to have a great impact on Sterling.
MPC Members Ramsden and Pill are due to deliver speeches on Tuesday, which are likely to cause volatility in the Sterling price, given the possibility of a pause in BOE rate hikes up ahead.
The Yen lost strength in early trading on Monday amidst speculation on BOJ’s new Governor. The USD/JPY was propelled upwards on Monday, touching the 133 level. Currently, the USD/JPY rate is driven primarily by the dollar’s direction, as markets weigh in on the implications of the Fed’s dovish shift. 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.
The Yen came under pressure on Monday, as rumors surfaced regarding the successor of BOJ Governor Haruhiko Kuroda. Kuroda 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 Japanese Government has reportedly approached Deputy BOJ Governor Masayoshi Amamiya for the position of BOJ Governor, although Japanese government officials have since denied this. Amamiya is also a firm supporter of the central bank’s ultra-loose monetary policy, though. A change in leadership with Amamiya at the helm would probably make little difference to BOJ policy. Market reaction reflected this eventuality, and the Yen tumbled after the rumors surfaced.
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 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.
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.
On the data front, several indicators of economic health are scheduled to be released on Tuesday for Japan, including, Average Cash Earnings, Household Spending, and Leading Indicators. These may affect Yen's price somewhat, although USD/JPY is expected to depend primarily on the dollar this week.
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