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Dollar propelled to 20-year high as inflation fears mount

Home >  Daily Market Digest >  Dollar propelled to 20-year high as inflation fears mount

Written by:
Myrsini Giannouli

13 May 2022
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Important calendar events

 

  • JPY: Annual M2 Money Stock
  • EUR: French Final CPI, Industrial Production
  • USD: Preliminary UoM Consumer Sentiment, Preliminary UoM Inflation Expectations, FOMC Member Mester Speech

USD

Higher than expected US inflation data propelled the dollar to a new 20-year high on Thursday, with the dollar index climbing to 104.9. Monthly PPI and Core PPI data released for the US on Thursday, showed that wholesale inflation rose by 0.5% last month and by 11% year to year in April. Producer prices keep rising, indicating that inflation rates are accelerating in the US. 

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 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 also remained high on Thursday, with the US 10-year treasury note yield close to 3%. 

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. 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. Similarly, Fed Member Bullard stated that a 50 bp rate hike seems appropriate for the next monetary policy meeting. 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. 

On Friday, Preliminary UoM Consumer Sentiment and Preliminary UoM Inflation Expectations are scheduled to be released and may provide indications of consumer spending and economic activity in the US. In addition, FOMC Member Loretta Mester is due to deliver a speech on Friday, which may affect the dollar, as markets have been reacting strongly to Fed rhetoric in the past few weeks.

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EUR 

The Euro plummeted against the rising dollar on Thursday, with the EUR/USD pair testing the 1.036 level support representing the 2016 low. 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. If the currency pair falls even further, it may encounter support near a 20-year low of 0.985.

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 but has recently shown signs of wavering, 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. 

French Final CPI and Eurozone Industrial Production data are scheduled to be released on Friday and may cause some volatility for the Euro, by providing indications of financial activity and inflation conditions in the EU.

EURUSD 1hr chart

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GBP 

The sterling has been under pressure for the past few weeks, falling against the dollar. On Thursday, the pound continued to retreat, weighed down by negative financial data for the UK. The GBP/USD rate declined to the 1.220 level on Thursday. 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. 

Several economic data were released on Thursday for the sterling, including 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 showed that were less optimistic than expected. The UK economy is still vulnerable, suffering from the effects of the pandemic and the war in Ukraine. Economic growth is stalling, with quarterly GDP rising by 0.8%, versus the 1% expected. Monthly GDP contracted by 0.1% in March, highlighting the risks that the British economy is facing.

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. Stagflation is a risk for the UK economy, as for many other countries, as economic stagnation coupled with rising inflation creates a toxic mix for the economy.

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 at a more aggressive pace.

GBPUSD 1hr chart

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JPY

The USD/JPY pair declined on Thursday, despite the dollar’s ascent to a new 2-year high. The USD/JPY fell to the 128 level on Thursday, retreating from last week’s high of over 131. 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. 

On Thursday, Bank Lending and Current Account data were released for Japan and were more optimistic about the state of the economy, providing support for the Yen. The Yen has been retreating for months, with market investor interest in the currency slowing down, despite global economic risks. The currency, which has been oversold, regained some of its lost ground on Thursday.

Japan’s 30-year government bond yield auction held on Thursday, gave an average yield of 1.02%, showing that Japanese bond yields are weakening, due to low demand. Overall, bond yields fell across Japan’s treasury curve on Thursday, giving low results, as active bids were low. 

Earlier 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, with the BOJ 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 persistently dovish stance of the BOJ has been putting 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.

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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