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Dollar dips as markets weigh Fed rate hike expectations

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Written by:
Myrsini Giannouli

25 January 2023
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Important calendar events

  • GBP: BRC Shop Price Index, PPI Input and Output
  • EUR: German IFO Business Climate, Belgian NBB Business Climate


The dollar slipped on Tuesday as markets weighed Fed rate hike expectations. The dollar index remained below the 102 level most of the day, boosted briefly by robust US economic activity data. US Treasury yields dipped on Tuesday, with the US 10-year bond yielding approximately 3.47%. 

US Flash Services and Manufacturing PMI released on Tuesday exceeded expectations providing support for the dollar. Flash Services PMI in January climbed to 46.6 from 44.7 in December, while Flash Manufacturing PMI rose to 46.8 in January from 46.2 in December. The upbeat economic data boosted the dollar and the dollar index spiked briefly above the 102 level, but slowly retreated later in the day.

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.

As interest in the Fed’s future policy direction mounts, the dollar will be especially sensitive to FOMC members’ speeches this week.



The Euro traded sideways against the dollar on Tuesday and EUR/USD oscillated around the 1.087 level. 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. 

Economic activity data released for the Eurozone on Tuesday were overall mixed, indicating that the EU economy is still struggling. Eurozone Flash Manufacturing PMI came out at 48.8 in January, which was an improvement from December’s 47.8 print. Eurozone Flash Services PMI Activity rose to 50.7 from 49.8 in December, registering a 6-month high. A print above 50 denotes industry expansion and an optimistic economic outlook.

ECB President Christine Lagarde delivered a particularly hawkish speech on Monday, 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 emphasized the central bank’s commitment to raising interest rates, stressing 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, while Dutch central bank chief Klass Knot 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. 

Minor economic activity indicators are due on Wednesday for the Eurozone, including German IFO Business Climate and Belgian NBB Business Climate. Market participants will also pay close attention to ECB members’ speeches to gauge the central bank’s monetary policy direction.

EURUSD 1hr chart



The Sterling collapsed on Tuesday on disappointing UK economic data. GBP/USD plummeted by 1.226 but recovered some of its losses later in the day. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.184. 

UK PMI data on Tuesday provided an overall pessimistic economic outlook, underlining the risk that Britain could slip into a recession. UK Flash Services PMI dropped to 48.0 in January from 49.9 in December, registering a 24-month low. A value below 50 denotes industry contraction and a drop in PMI print indicates worsening business activity. UK Flash Manufacturing PMI was somewhat improved in January, rising to 46.6 from 44.4 in December but remained low. 

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. 

BRC Shop Price Index, as well as PPI Input and Output data on Wednesday, may affect the Sterling. BOE rhetoric is also expected to influence Sterling's price.

GBPUSD 1hr chart



The Yen edged higher on Tuesday, supported by a hot inflation print in Japan. USD/JPY dropped slightly, touching the 130 level. 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.

Flash Manufacturing PMI in January remained at 48.9, the same as December’s print. Flash Services PMI though, climbed to 52.4 from 51.1 in December. BOJ Core CPI rose to 3.1% year-on-year, exceeding expectations of a 2.9% print. Japan's inflation has exceeded the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households. National Core CPI released last week for December was at 4.0%, rising above November’s 3.7% print. 

Monetary Policy Meeting Minutes of the BOJ’s previous meeting in December released on Monday showed that Government Officials 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. 

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.

USDJPY 1hr chart


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Written by:
Myrsini Giannouli

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