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Dollar climbs as inflation reaches 40-year high

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Written by:
Myrsini Giannouli

13 April 2022
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Important calendar events

  • JPY: Monthly Core Machinery Orders, M2 Money Stock, Scheduled speech by BOJ Governor Kuroda
  • USD: Monthly PPI and Core PPI, 30-y Bond Auction
  • GBP: Annual CPI and Core CPI, Annual HPI, Annual RPI, Monthly PPI Input and Output

USD

The dollar continued climbing on Tuesday, with the dollar index reaching above 100.30. Yields also rose across the US treasury curve, with the US 10-year treasury note climbing above 2.8% on Tuesday, as investors anticipate a more aggressively hawkish Fed policy.

CPI data released on Tuesday showed headline inflation in the US rose to 8.5%, its highest rate since 1981, while core CPI (excluding food and energy) came below expectations, at 6.5%. Soaring inflation rates in the US increased expectations of a high rise in the Fed’s benchmark interest rate, buoying the dollar. 

Over the past couple of weeks, Fed rhetoric has been one of the primary drivers of USD price, as the Fed signals a faster pace of policy tightening in the US. Markets are beginning to price in a steep rate hike of 50 base points at the Fed’s next policy meeting in May. Markets have been pricing in a total of over 225 base points of additional interest rate hikes this year, boosting the dollar.

This week, Fed rhetoric continued raising expectations of a steep rate hike, with FOMC member Evans commenting on Monday that an interest rate rise of 50 base points in May seems highly likely. On Tuesday, FOMC Member Brainard delivered a speech about the economy at an online event hosted by the Wall Street Journal. Brainard emphasized in her speech the importance of bringing down inflation in the US through rate hikes and balance sheet trimming. Brainard was formerly considered one of the more dovish FOMC members and her recent hawkish tones carry extra weight, further boosting the dollar. 

FOMC minutes released last week showed that several Fed officials were in favor of a rate hike of 50 base points last month, increasing the chances of a 50 bp increase in the Fed’s benchmark interest rate in May. FOMC minutes also signaled that the US Central Bank would reduce its bond holdings by as much as $95 billion per month. 

Reports of escalating violence against Ukraine and increased sanctions on Russia have also turned investors’ interest towards safe-haven assets. The Biden administration announced new sanctions last week, targeting Russia’s largest financial institutions to increase economic pressure on Russia. 

Several important financial indicators are scheduled to be released on Wednesday for the dollar, including Monthly PPI and Core PPI, 30-y Bond Auction. The PPI data, in particular, are leading indicators of inflation and their release may cause some volatility in the currency. 

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EUR 

EUR/USD fell on Tuesday, reaching the 1.082 level, its lowest point since May 2020. If the currency pair goes up, it may encounter resistance at 1.118, while if it declines, support may be found at the 1.080 level. 

High inflation data released on Tuesday for the US and increasingly hawkish Fed rhetoric boosted the dollar. The Euro, which had been boosted temporarily from the results of the first round of the French elections, weakened on Tuesday, as markets began to digest the fact that the outcome of the French elections is by no means certain.

The Euro had rallied on Monday, as the reports of the French Presidential election results provided support for the currency. The results for the first round of the Presidential Elections in France showed Emmanuel Macron to be in the lead, although his adversary for the second round, Marine Le Pen, is not far behind in votes. Macron’s even marginal win, boosted the Euro, providing a promise of political stability for one of the Eurozone’s leading economies.

Several financial data were released on Tuesday for the Eurozone, including ZEW Economic Sentiment, German ZEW Economic Sentiment, German Final CPI, German WPI, and French Trade Balance. These are indicators of inflation and economic health and were overall mixed for the direction of the Eurozone economy. The ZEW data, in particular, depend mostly on the state of Germany’s economy, which is the EU’s leading economy and has shown signs of economic recovery, although not as much as previously hoped for. 

A new round of EU sanctions on Russia last week also weighed down the Euro. The new EU sanctions will target the energy sector for the first time, with a ban on coal imports from Russia worth €4bn a year. In addition, Russia’s demands for payments of energy imports in Roubles have increased concerns of an impending energy crisis in Europe, putting pressure on the Euro. Germany has already entered the initial phases of implementing an emergency gas law, preparing for rationing gas resources among its population. 

The minutes of the latest ECB meeting released last week indicated that many of the Central Bank’s members have expressed concern about the high inflation levels in the EU and were in favor of taking immediate steps towards monetary policy normalization. The ECB however, is hesitant to raise its interest rates, 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.

The ECB has been pursuing a more cautious fiscal policy than other major Central Banks and does not plan to raise its benchmark interest rate before the end of its bond-buying program in the third quarter of 2022. 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.

On Thursday, April 14th, all eyes are going to be on the ECB, which is going to announce its main refinancing rate. Even though the EU Central Bank is not expected to change its benchmark interest rate at this meeting, the ensuing Monetary Policy Statement is going to be scanned closely by market participants and will likely cause some volatility for the Euro.

EURUSD 1hr chart

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GBP 

The Sterling gained some ground against the dollar early on Tuesday but pared its gains later in the day. The GBP/USD rate plummeted later on Tuesday, as the dollar gained strength, while the pound weakened, and is currently testing the 1.300 level support. If the GBP/USD rate goes up, it may encounter resistance at the 1.331 level and further up near the 1.341 level, while if it declines, further support may be found near the 1.267 level. 

Several financial indicators were released on Tuesday for the sterling, including the Average Earnings Index, Claimant Count Change, and Unemployment Rate, which are indicators of employment and overall economic health in the UK. Overall, the data was slightly positive, showing unemployment claims have decreased and provided a little support for the sterling early in the day.

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, there are signs that its stance may soften in the coming months, weighed down by a fragile economy. In contrast, the increasingly hawkish Fed rhetoric is boosting the dollar against the pound.

BOE Governor Andrew Bailey has stressed the importance of delivering a clear message to the public regarding the BOE’s future policy. He has stated that the joint effects of COVID and the war in Ukraine on the global economy would take some time to manifest fully and, in the meantime, the BOE would need to remain cautious. Bailey has also warned that the energy crisis in the UK was going to be ‘historic’, displaying a relatively dovish stance these past couple of weeks, especially compared to the more hawkish Fed rhetoric. 

UK inflation is already at a 30-year high and expected to rise further, with a peak rate close to 9% in Q4. Rising commodity prices and import costs in the UK, and especially the high costs of imported energy, are driving inflation rates even higher. 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.

Several financial indicators are scheduled to be released on Wednesday for the sterling, including Annual CPI and Core CPI, Annual HPI, Annual RPI, Monthly PPI Input, and Output. These are indicators of inflation and overall economic health and the CPI data, in particular, are key indicators of consumer inflation and may cause volatility for the currency, as they may influence the BOE’s future policy.

GBPUSD 1hr chart

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JPY 

The Yen traded sideways against the dollar on Tuesday, with the USD/JPY rate fluctuating around the 125.3 level. The USD/JPY is following an uptrend and if it rises further, it may encounter resistance at the 2015 high of 125.8. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level. 

Annual PPI and Annual Bank Lending data were released on Tuesday for Japan, which are indicators of inflation and economic health. PPI data showed that inflation in Japan is rising, providing support for the Yen.

The safe-haven dollar was boosted these past few days by reports of renewed hostilities in Ukraine and new sanctions on Russia. The Yen is also considered a safe-haven currency but has not been affected as much as other safe-haven assets by the crisis in Ukraine, and many investors have been doubting its safe-haven status. Rather, the primary driver of the Yen over the past few months has been the BOJ’s fiscal policy.

Bank of Japan Governor Haruhiko Kuroda delivered a speech on Monday, re-affirming the BOJ’s commitment to a monetary easing policy. Kuroda stated that Japan’s economy is recovering from the impact of the pandemic, but stressed that the war in Ukraine has introduced a high level of uncertainty over the country’s economy. 

The Bank of Japan has maintained its negative interest rate from -0.10%, while other Central Banks 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.

Last week Kuroda commented on the weakening Yen, expressing concern that recent yen moves have been somewhat rapid. Kuroda however, reiterated the benefits of a weaker Yen especially to Japan’s exports, although he acknowledged the added burden of the weak currency on households. 

Japan’s core CPI may climb around 2% in April, similar to other countries that are expected to see a peak in inflation rates around the same time, largely due to the effect of the increase in 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. The rising cost of oil is causing goods prices to rise in Japan, with oil imports accounting for 80% of the country’s oil consumption. 

Monthly Core Machinery Orders and M2 Money Stock data are scheduled to be released on Wednesday, which is minor economic indicators and are not expected to affect the Yen significantly. More importantly, Bank of Japan Governor Haruhiko Kuroda is due to deliver a speech on Wednesday at the Trust Companies Association of Japan's annual meeting, in Tokyo and his speech may cause some volatility for the Yen.

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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