Important calendar events
The US dollar has been rising these past few weeks, surpassing its pandemic high of 2020 and reaching a 20-year record of 103.9. The dollar remained firm on Tuesday, ahead of the Fed meeting on Wednesday, with the dollar index showing very little volatility and moving above the 103.5 level.
Yields also rose across the US treasury curve this past week, with the US 10-year treasury note rising to 3% for the first time since 2018 and reaching 3.1% on Tuesday.
Several US key indicators were released on Tuesday, including JOLTS Job Openings, Factory Orders, Wards Total Vehicle Sales. These were overall positive for the US economy and the employment sector in the US. With the Fed policy decision looming ahead, the release of this data provided further support for the dollar on Tuesday.
Over the past few 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 have already priced in a steep rate hike of 50 base points at the Fed’s next policy meeting on Wednesday. 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 highly-anticipated Fed meeting is scheduled for Wednesday and its outcome is expected to affect the dollar considerably. The US Federal Reserve is expected to raise its benchmark interest rate by at least 50 base points on Wednesday, based on recent FOMC member's statements. A series of Fed rate hikes have already been priced in by markets for this year, driving the dollar up over the past few weeks. If the Fed decides on a conservative rate hike of 25 bps, it might seem less hawkish than expected and could drive the dollar down, while a more hawkish policy and a higher rate hike of 75 base points could see the dollar climbing even further. Even a rate hike of 50 bps may have been fully priced in and could see the dollar decline.
Another aspect that will affect the dollar is the Fed’s potential decision to move towards a policy of quantitative tightening this week. The Fed’s balance sheet has risen to approximately 9 trillion USD during the pandemic and many market participants expect the US Central Bank to address this at its meeting on Wednesday and decide to start trimming its balance sheet.
Continued Russian hostilities against Ukraine have increased risk-aversion sentiment these past two months, providing support for the safe-haven dollar. The situation between Russia and Ukraine continues to escalate, as Russian President Vladimir Putin makes threats about using nuclear weapons, while he cuts off the gas supply to Poland and Bulgaria.
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 Tuesday, the currency pair continued trading low ahead of the Fed meeting on Wednesday, struggling to hold the 1.050 level early in the day, then rising to 1.051. Volatility was low on Tuesday, as market participants await the outcome of the Fed monetary policy meeting on Wednesday. If the currency pair falls even further, it may find support near the 2016 low around the 1.036 level. The outlook for the pair is bearish, but if the currency pair goes up, it may encounter resistance at 1.118.
Increased risk-aversion sentiment and hawkish Fed rhetoric have boosted the dollar at the expense of other currencies, with the Euro suffering heavy losses last week after Russian President Vladimir Putin announced that Russia would suspend gas supplies to Poland and Bulgaria. The Fed is expected to move towards a tighter fiscal policy and has been performing a series of rate hikes, with a 50 base point rate hike expected to be announced this week.
The 10-year German Bund yield has risen to 1% for the first time in eight years, as expectations that the ECB will need to increase rates continue to grow. Ecofin and Eurogroup meetings were also held on Tuesday, at which the direction of the Eurozone economy was discussed.
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.
The ECB however, has so far been 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. As the Fed is expected to raise its benchmark interest rate significantly at its policy meeting this week, the Euro remains at a disadvantage from the difference in interest rates.
Many of the Central Bank’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. Last week, Lagarde delivered a speech that was considered more hawkish than expected, stressing that the ECB will be following a different route than the Fed, but leaving the door open for a rate hike in July.
Several important indicators are scheduled to be released for the Eurozone on Wednesday, including German Trade Balance, Spanish Unemployment Change, Spanish and Italian Services PMI, French and German Final Services PMI, and Eurozone Final Services PMI. These data provide a measure of economic activity for some of the Eurozone’s leading economies. The PMI data, in particular, are key indicators of economic health and may impact the ECB’s monetary policy.
The sterling has been under pressure, falling against the dollar, with the GBP/USD rate falling as low as 1.240 last week. The GBP/USD rate was sluggish on Tuesday, ahead of the Fed meeting, trading sideways around the 1.250 level. 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 two-year low at 1.206.
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 stated that the BOE is walking a tight line between inflation and economic recession and warned of the risks of tightening monetary policy too fast. Recent economic data show that the British economy is sluggish and economic recovery is still a long way off.
The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Rising commodity prices and import costs in the UK are driving inflation rates higher, with headline inflation reaching 7%. UK inflation has hit a 30-year high and is expected to rise further in the coming months, with a peak rate close to 9% in Q4. Soaring inflation rates in the UK increase market expectations that the BOE will raise its benchmark interest again this week.
The Official BOE interest rate is going to be announced this week on Thursday, May 5th, just a day after the Fed’s interest rate announcement. The Bank of England is expected to raise its benchmark interest rate on Thursday by at least 25 base points, after already performing two consecutive rate hikes in its previous meetings, bringing its rate to 1%. Markets have already priced in approximately six BOE rate hikes this year, although recent BOE rhetoric seems to move towards a more conservative monetary policy. It is also possible that the BOE will keep its interest rate unchanged in this meeting, while a steeper rate hike than 25 base points is considered highly unlikely at the time.
In this BOE meeting, we expect to see a divergence between Fed and BOE policies, with the Fed moving towards a more aggressive economic tightening. 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, with most market participants becoming more modest in their expectations of a BOE rate hike. Another important aspect that will likely affect the pound, is the BOE’s potential move towards quantitative tightening. In its last policy meeting in February, the BOE announced that it would move towards a passive tightening of its fiscal policy, by not reinvesting maturing gilts to keep their holdings constant. The BOE retains approximately GBP875 billion of UK government bond holdings and may decide to move towards a more active tightening this week by selling UK gilts, to gradually reduce this amount.
Several economic indicators are scheduled to be released on Wednesday for the UK, such as M4 Money Supply, Mortgage Approvals, and Net Lending to Individuals. These however are not likely to have a strong impact on the currency. The sterling will likely be affected more this week by the impending Fed and BOE policy meetings.
The Yen plummeted to a 20-year low last week, following the BOJ’s latest monetary policy meeting. The USD/JPY traded above 131, its highest price in 20 years. The USD/JPY traded sideways on Tuesday, with very low volatility, remaining close to the 130.1 level. If USD/JPY continues its ascend, 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.
The primary driver of the Yen over the past few months has been the BOJ’s fiscal policy. Last week, the Yen 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.
The BOJ announced its main interest rate last Thursday and released an outlook report, detailing the factors that shape its monetary policy. The Bank of Japan continued its ultra-accommodating policy and massive stimulus program. The BOJ also 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 BOJ released a press conference after the conclusion of the meeting, with BOJ Governor Haruhiko Kuroda issuing a dovish statement that pushed the Yen to record lows. Kuroda vowed to continue the bank’s ultra-easy monetary policy, stating that the weakening Yen is not part of the BOJ’s considerations.
The BOJ also stated that it would continue to buy an unlimited amount of Japanese treasury bonds, defending their current low yield. Japan’s 10-year government bond yield is currently close to 0.25%, more than an order of magnitude lower than the respective US 10-year bond, which is offered with a yield close to 2.8%. The large divergence in bond yields makes the low-yielding Yen less appealing to investors than the dollar, pushing its price further 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.
This week, May 3-5 are bank holidays in Japan and very few economic events are scheduled for this week in Japan. As a result, the Yen is expected to be influenced mainly by external factors this week, such as the war in Ukraine, the dollar status, and the US Fed meeting.
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