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Dollar buoyed by strong inflation data

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Written by:
Myrsini Giannouli

12 May 2022
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Important calendar events

  • USD: Monthly PPI and Core PPI, Unemployment Claims, 30-y Bond Auction, FOMC Financial Stability Report
  • JPY: BOJ Summary of Opinions, Bank Lending, Current Account, 30-y Bond Auction, Economy Watchers Sentiment
  • GBP: Annual Preliminary GDP, Construction Output, Monthly GDP, Goods Trade Balance, Index of Services, Industrial Production, Manufacturing Production, Preliminary Business Investment

USD

The dollar rose to a 20-year high early on Monday, with the dollar index rising to 104.19 and remaining high on Tuesday, reaching above 103.9. On Wednesday, higher than expected US inflation data catapulted the dollar index again above 104.

The US dollar has been rising these past few weeks, surpassing its pandemic high of 2020, supported by hawkish Fed monetary policy and strong inflationary pressures. US yields remained high on Wednesday, with the US 10-year treasury note moving above 3% after the release of the CPI data. 

On Wednesday, US CPI and Core CPI data exceeded expectations, showing that US inflation is not slowing down as much as forecasted. US consumer prices rose at an annual pace of 8.3% in March according to Wednesday’s data, boosting the dollar even further. Inflation rates in the US are expected to rise even further, as April’s inflation rates are going to reflect the recent rise in energy prices. 

The dollar has been boosted by hawkish Fed policy and increased risk-aversion sentiment. Continued Russian hostilities against Ukraine have increased risk-aversion sentiment these past two months, providing support for the safe-haven dollar. As there is still no end in sight to the crisis, the dollar’s appeal as an investment remains high. 

Last week, the US Federal Reserve raised its benchmark interest rate by 50 base points to 1%. This is the first time that the Fed has performed such a steep rate hike since 2000. A rate hike of 50 bp, however, had been fully priced in by markets and some market participants were even anticipating a 75 bp rate hike. Markets have been pricing in a total of over 225 base points of additional interest rate hikes this year, with the main Fed rate expected to rise to 2.75%. The dollar plummeted after the Fed meeting last week, but rallied later in the week, as markets had time to digest the news. 

Following the meeting, Fed Chair Jerome Powell stated firmly that the Fed is not considering a 75 bs rate hike for the next policy meetings. Powell’s statement dashed market expectations of an ultra-high rate hike in the following months, checking the dollars ascend.

The Fed also announced last week that it would move towards a policy of gradual quantitative tightening. The Fed’s balance sheet has risen to approximately 9 trillion USD during the pandemic and the US Central Bank has decided to start trimming its balance sheet.

Several FOMC Members delivered speeches this week, with Fed member John Williams emphasizing the need to tackle high inflation rates and stating that 50 bs rate hikes at the Fed’s next policy meetings are a sensible option. US President Joe Biden also delivered a speech on Wednesday, stating that tackling inflation is the US Government’s number 1 priority at the moment, together with maintaining a high level of employment in the US. 

Several financial indicators are scheduled to be released for the US on Thursday, including Monthly PPI and Core PPI, Unemployment Claims, 30-y Bond Auction, and FOMC Financial Stability Report. The PPI data, in particular, are key inflation indicators and may have affected dollar prices, as inflation rates are expected to influence the Fed's monetary policy in the coming months.

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EUR 

The Euro was supported on Wednesday by hawkish ECB rhetoric, while the dollar weakened. The Euro has been under pressure by the rising dollar these past few weeks, with the EUR/USD rate trading near the 1.050 level, below a five-year low. On Wednesday, the EUR/USD pair traded near the 1.053 level. If the EUR/USD rate declines, it may find support near the 2016 low around the 1.036 level. The outlook for the pair is still bearish, but if the currency pair goes up, it may encounter resistance at 1.093 and further up at 1.118. 

German CPI data released on Wednesday were in line with expectations at 7.4%, showing an incremental rise in inflation rates in the Eurozone as the effect of the increase in energy prices is starting to show in April’s inflation data. German CPI is considered to act as a barometer for Eurozone inflation, with French CPI data scheduled to be released later in the week. Eurozone CPI flash inflation estimates have risen by 7.5% on an annual basis, highlighting the problem of rising energy and commodity prices in the EU. Core CPI estimates rose to 3.5%, further increasing the likelihood of an ECB rate hike in July. Markets are pricing in 3 ECB rate hikes this year, of at least 25 base points each. 

Increased risk-aversion sentiment and hawkish Fed policy have boosted the dollar at the expense of other currencies, with the Euro suffering heavy losses these past few weeks. Fears of an energy crisis in the EU also hold the Euro down, as the EU may announce an oil ban on Russian oil imports within the week. 

The US Federal Reserve raised its benchmark interest rate by 50 base points last week, highlighting the difference in monetary policy between the EU and the US and driving the Euro down. The ECB has so far been hesitant to raise its interest rates though, as the Eurozone economy is still struggling to recover from the effects of the pandemic. The ECB is trying to avert a dangerous economic effect known as stagflation, the mix of economic stagnation and high inflation rates.

Many of the ECB’s members have repeatedly expressed concern about the high inflation levels in the EU and are in favor of taking immediate steps towards monetary policy normalization. ECB President Christine Lagarde is in favor of a more dovish stance, however, and has stated that Eurozone inflation is expected to rise in the following months, while economic growth is expected to stall. Even Lagarde however, has shown recent signs of wavering though, as rising inflationary pressures are forcing the ECB to act to drive inflation down. 

On Wednesday, Lagarde showed a shift towards a more hawkish stance, stating that the ECB will likely end its bond-buying program in the third quarter of 2022 and a rate hike might follow just a few weeks later.

German Buba President Joachim Nagel, who is one of the more hawkish ECB members, stated earlier this week that he expects the ECB to gradually start raising interest rates this summer. On Wednesday, he emphasized that inflation rates are expected to rise even further and emphasized that the ECB should end its Quantitative Easing program in June and start raising its interest rates in July to tackle soaring inflation rates. ECB members are starting to agree on a more hawkish policy starting in the third quarter of the year and the consensus between them seems to be that the ECB will perform its first rate hike in decades at its next policy meeting in July. 

EURUSD 1hr chart

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GBP 

The sterling has been under pressure for the past few weeks, falling against the dollar. The pound traded sideways against the dollar on Wednesday, with the GBP/USD pair moving around the 1.230 level and testing the 1.225 level support later in the day. If the GBP/USD rate goes up, it may encounter resistance at the 1.263 level and further up near the 1.331 level, while if it declines, support may be found near the two-year low at 1.206. 

On Tuesday, the parliamentary year was opened formally by the annual Queen’s Speech. This year, the Queen’s Speech was delivered by Prince Charles for the first time. New legislative items were introduced in the speech and later, British PM Boris Johnson and Sir Keir Starmer debated the speech’s policies.

The sterling has been losing ground against the dollar due to the divergence in monetary policy between the Fed and the BOE. Although the BOE started the year with a strong hawkish policy, it has recently backed down and moderated its stance, weighted down by the still fragile British economy. In contrast, the increasingly hawkish Fed policy is boosting the dollar against the pound.

Last week, the Bank of England raised its benchmark interest rate by 25 base points, after already performing three consecutive rate hikes in its previous meetings, bringing its rate to a 13-year high of 1%. The BOE stressed once more the dangers of recession, as the economic contraction is battling with inflation rates that are predicted to surge to 40-year highs of 10% in the coming months. The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. 

In last week’s BOE and Fed meetings, we are starting to see a divergence between Fed and BOE policies, with the Fed moving towards a more aggressive economic tightening by raising its interest rate by 50 bp, versus the 25 bp of BOE’s interest raise. The difference between the Fed’s and the BOE’s stance over the past few weeks has been driving the sterling down and propping up the dollar. 

Even though the Fed thwarted market expectations of a higher rate hike last week, investors still see the Fed adopting a more decisive approach towards tackling rising inflation rates than the more hesitant BOE. Interestingly enough, both Central Banks have now brought their interest rates to the same level of 1%, but the BOE is perceived to be slowing down, while the Fed is moving with a more aggressive pace.

Several economic data are scheduled to be released on Thursday for the sterling. These include Annual Preliminary GDP, Construction Output, Monthly GDP, Goods Trade Balance, Index of Services, Industrial Production, Manufacturing Production, and Preliminary Business Investment. These are indicators of economic health and activity and may have some impact on the sterling.

GBPUSD 1hr chart

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JPY

The USD/JPY traded sideways on Wednesday, along with the 130 level. If USD/JPY continues to rise, it may find resistance at the 2002 high of 135.3. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level. 

This week, Japan’s 10-year government bond yield auction maintained the 0.25% interest rate of the bonds. The BOJ continues to buy an unlimited amount of Japanese treasury bonds, defending their current low yield.  In contrast, the respective US 10-year bond is offered with a yield of over 3%, more than an order of magnitude higher than the Japanese bond. The large divergence in bond yields makes the low-yielding Yen less appealing to investors than the dollar, pushing its price further down.

The primary driver of the Yen over the past few months has been the BOJ’s fiscal policy and has been pushed down by the persistently dovish stance of the BOJ. Bank of Japan officials acknowledge the impact on the Japanese economy from increased import costs due to the weak yen but persist in following an ultra-easy monetary policy to support the struggling economy. While other countries are moving towards quantitative tightening to return to pre-pandemic fiscal policies, Japan continues to pour money into the economy. Monetary policy meeting minutes released on Monday, confirmed that ongoing monetary easing remains necessary to boost the economy, adding more pressure on the Yen.

In its latest monetary policy meeting, the Bank of Japan continued its ultra-accommodating policy and maintained its negative interest rate of -0.10%, in contrast to other Central Banks, which are moving towards a policy normalization after the pandemic and are raising their benchmark interest rates. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.

The safe-haven dollar is boosted by continuing Russian hostilities against Ukraine. The Yen is also considered a safe-haven currency but has been underperforming, despite an increased risk-aversion sentiment, and many investors have been doubting its safe-haven status.

Several financial data are scheduled to be released on Thursday for Japan. These include BOJ Summary of Opinions, Bank Lending, Current Account, 30-y Bond Auction, and Economy Watchers Sentiment. These may cause some volatility for the currency, especially the BOJ reports, which may provide insight into the BOJ's future policy.

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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