Important calendar events
The dollar edged lower on Monday, with the dollar index dropping to 110.1. US Treasury yields gained strength, however, in the wake of last week’s Fed rate hike. The US 10-year bond yielded 4.2% on Monday, while the US 2-year bond yielded above 4.7% maintaining its highest level since 2007.
The dollar has been trading in overbought territory and has been slipping since last week. The USD was boosted by the Fed’s rate hike but weak jobs data pushed the dollar down last week and the dollar’s sell-off continued on Monday.
The US mid-term Congressional elections will take place on Tuesday and their outcome may cause volatility in dollar prices. Concerns that the Democratic party might lose control of Congress in Tuesday’s elections, leading to political instability in the US, have pushed the dollar down.
The US Federal Reserve voted to increase interest rates by 75 basis points at its monetary policy meeting last week. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate in a range of 3.75% to 4.0%.
The FOMC Statement issued by the Fed contained a subtle change in forward guidance. The tone of the statement was more cautious than before, indicating that the Fed may be pondering slowing the pace of rate hikes. Market expectations are currently in favor of a 50-bps rate hike in December and a 25-bps hike in January. Rate hikes are expected to taper off in 2023 as the central bank moves into a stable interest rate.
High-risk aversion sentiment has been prevalent throughout the year, increasing the safe-haven dollar’s appeal. At the same time, the Fed’s increase in interest rates is attracting investors who seek higher returns, boosting the dollar.
US inflation rose by 0.4% every month in September, reaching 8.2% on an annual basis, dropping only slightly from last month’s 8.3%. Price pressures continue to increase in the US, putting extra strain on the Federal Reserve to continue with its policy of monetary tightening. Inflation rates have proved to be resistant to economic tightening and continue to rise.
Several indicators of economic activity are scheduled to be released on Tuesday for the US and may affect the dollar in the wake of last week’s Fed meeting.
The Euro regained the parity level with the dollar on Monday, on robust EU economic data. EUR/USD climbed above the parity level, reaching 1.003, as the dollar declined. If the EUR/USD pair declines, it may find support near the 0.963 level and further down at the 0.953 level representing the 2002 low. If the currency pair goes up, it may encounter resistance near 1.009.
German industrial production data released on Monday for September exceeded expectations, rising by 0.6% against the 0.2% expected and a decline of 1.2% in August. The Sentix Investor Confidence index on Monday was also higher than expected, even though it was still negative, it printed at -30.9 against expectations of -35.2 and -38.3 the previous month. This is a key indicator of economic health in the EU and, although a negative result indicates pessimism, the EU economic outlook appears to be improving.
The Euro exchange rate has been heavily influenced by the dollar’s surge in the past few months, as the US Federal Reserve continues to raise interest rates in an aggressive fight against inflation. The US Fed raised interest rates by 75 bps at its policy meeting last week, bringing its interest rate up to 4.0%. In its latest monetary policy meeting last week, the ECB raised its interest rate by 75 basis points to 1.5%, the highest since 2009. Soaring EU inflation rates are forcing the central bank to hike rates aggressively to reduce price pressures.
The ECB however, cannot match the Fed’s aggressively hawkish pace, as Eurozone economic outlook is poor, showing signs that the EU is entering a recession. ECB President Christine Lagarde highlighted the unique problems that have been plaguing the Eurozone economy in her speeches last week after the Fed monetary policy meeting. Lagarde stated that the ECB will continue raising interest rates to bring inflation down to the central bank’s 2% target and would not be deterred even by a recession in the Eurozone. She warned, however, that the EU cannot mirror the Fed’s rate hikes as the EU economy cannot withstand such aggressive tightening.
Eurozone's economic outlook is poor, with analysts predicting stagnation later this year and in the first quarter of 2023, limiting the ECB’s ability to raise interest rates. Even though further rate hikes seem certain, the magnitude of the hikes may decrease if the EU shows signs of entering a recession. Preliminary Flash GDP data seem to support this scenario. Flash GDP for the third quarter of 2022 showed economic growth of only 0.2% against an expansion of 0.8% in the previous quarter. Stagflation becomes a real headache for the ECB, which will be forced to battle inflation without the support of a robust economic background.
Record-high Eurozone inflation data indicate that the ECB’s efforts to tackle inflation have not been successful so far. Eurozone inflation in October reached 10.7% versus September’s print of 9.9%. Price pressures continue to increase in the EU, driven primarily by energy prices.
Several economic activities and health indicators are scheduled to be released on Tuesday that may affect the Euro, such as French Trade Balance, Italian Retail Sales, and Eurozone Retail Sales. The ECB is forced to adjust its monetary policy on a meeting-by-meeting basis, raising interest rates as far as the Eurozone’s fragile economic outlook will allow, and will rely on economic indicators to determine the aggressiveness of its fiscal policy.
The Sterling recovered on Monday, extending Friday’s gains, as the dollar edged lower. Renewed risk appetite on Monday benefitted the riskier Sterling and pushed the safe-haven dollar down. GBP/USD climbed above the 1.149 level resistance, reaching 1.153. If the GBP/USD rate goes up, it may encounter resistance near 1.164, while support may be found near 1.125 and further down at the new all-time low of 1.035.
The Fed increased interest rates by 75 bps last week, putting pressure on the Sterling. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate up to 4.0%. The BOE matched the Fed’s rate hike only a day later, bringing the total bank rate to 3.0%. BOE members voted unanimously to raise the official bank rate by 75 basis points to tackle soaring inflation in the UK.
BOE did not offer specific forward guidance, however, suggesting that future rate hikes may be softer than expected. BOE Governor Andrew Bailey warned that the country is already in recession, which could point to a shift in the BOE’s priorities, from battling inflation to surviving recession. The BOE predicts that the recession could last for almost two years, with expansion not expected again till mid-2024.
The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down. Annual inflation returned to 40-year highs in September, climbing to 10.1%, after cooling to 9.9% in August. Rising UK inflation is forcing the BOE to make some tough choices.
The Sterling has also been weakened from a prolonged period of political instability. Political instability has been playing a major part in the currency’s decline over the past few months, driving the pound to an all-time low.
PM Sunak has vowed that economic stability will be at the heart of his administration’s agenda. Foreign minister James Cleverly has indicated that the much-anticipated new fiscal plan is expected on November 17th and is reported to be a complete reversal of the previous government’s controversial budget. Instead of tax cuts, the current government is likely to go with tax hikes, which will be a tough sell on the British public.
The Yen gained strength on Monday, benefitting from the dollar’s decline. The USD/JPY rate extended Friday’s losses, dropping to 146.2. If the USD/JPY pair falls, support might be found near 145 and further down at 143.5. If the pair climbs, it may find resistance at 149.5, further up at 151.9, and higher still at the 1990 high near 160.
The highly-anticipated Fed meeting last week caused high volatility in dollar price, as FOMC members voted on another 75-bp rate hike. The latest BOJ policy meeting held few surprises, since the BOJ left its monetary policy unchanged, as expected. The BOJ maintained its ultra-easy monetary policy keeping its main refinancing rate at -0.10%. Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. 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 BOJ revised core CPI projections for 2022 to 2.9% from 2.3% previously, as recent inflation data in Japan exceeded expectations. The central bank also kept its 10-year Japanese Government Bond yield target at plus or minus 25 basis points around 0.00%. With the corresponding US bonds yielding above 4.0%, the difference in bond yields is putting pressure on the Yen.
Japanese authorities recently staged interventions to support the collapsing Yen, as evidenced by the currency’s sudden surges. The USD/JPY had moved well above the psychological level of 150 when it plummeted suddenly in what was undoubtedly large-scale selling of dollars and buying Yen. The suspected interventions failed to stem the tide, however, and the Yen continued to retreat. The Japanese government cannot support the Yen indefinitely, as continuous interventions would not be sustainable.
The USD/JPY rate is expected to hinge largely on the dollar’s movement this week, although market participants remain wary of further surprise interventions from the government of Japan. Several economic activities and health indicators are also due to be released on Tuesday for Japan and may affect the Yen's price. These include Average Cash Earnings, Household Spending, BOJ Summary of Opinions, and Leading Indicators.
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