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Dollar propelled to fresh 20-year highs

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Written by:
Myrsini Giannouli

06 July 2022
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Important calendar events

  • EUR: EU Economic Forecasts, German Factory Orders, Retail Sales
  • GBP: UK Construction PMI, MPC members Pill, and Cunliffe Speeches
  • USD: Final Services PMI, JOLTS Job Openings, ISM Services PMI, FOMC Meeting Minutes

USD

The dollar was propelled to a fresh 20-year high on Tuesday, with the dollar index climbing above the 106 level and reaching 106.6. Global recession concerns are rising, propping up the safe-haven dollar, while other currencies, such as the Euro and the Sterling are pushed down. US Bond yields on the other hand fell on Tuesday, with the US 10-year treasury note yielding below 2.8%.

The global economic outlook is poor, with a recession threatening many countries. Rampant inflation, combined with tightening monetary policy creates a toxic economic mix. Recession fears and geopolitical risks increase risk aversion sentiment, boosting the safe-haven dollar. 

Concerns about the US economic downturn spurred by weak US economic data, however, are putting a lid on the dollar’s ascend. Deteriorating economic health in the US is raising recession concerns however and limits the US Federal Reserve’s ability to tighten its fiscal policy. The dollar has been supported by hawkish Fed policy but the precarious state of the US economy is putting pressure on the currency.

In its latest policy meeting, the US Federal Reserve voted to raise its benchmark interest rate by 75 points, taking aggressive action against inflation and bringing its interest rate to 1.75%. Record high US inflation rates have forced the Fed to ramp up its efforts by performing its steeper rate hike since 1994.

High US inflation rates are forcing the Fed to tighten its monetary policy. PPI in Jun climbed 0.8% for the month and 10.8% on an annual basis, falling close to the historically high levels reached in March. Rising costs of food and energy have contributed to soaring inflation rates in the US. 

US Final Services PMI data are scheduled to be released on Wednesday, which are important economic indicators and may affect the dollar. FOMC Meeting Minutes are also going to be released on Wednesday. These are highly anticipated and are going to be scanned thoroughly by market participants, as they may provide additional insight into the Fed’s monetary policy direction. and may cause volatility in the dollar’s price. In addition, FOMC member Williams is due to deliver a speech on Wednesday, which may influence the dollar. 

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EUR

The Euro plummeted on Tuesday reaching a two-decade low, pushed down by weak EU economic data and a strong dollar. The EUR/USD rate crashed below the 1.036 level support which represents the 2016 low and fell as low as 1.024 for the first time since December 2002. If the currency pair goes up, it may encounter resistance at 1.078. If the EUR/USD continues to fall, it may find support near the 20-year low of 0.985.

Spanish, Italian, French, and German Services PMI, as well as Eurozone Final Services PMI, were released on Tuesday. These are indicators of economic health and the data were overall disappointing for the state of the EU economy, pushing the Euro down. French Services PMI and Industrial Production data, in particular, fell below expectations, indicating that the French economy is sluggish. Eurozone Services PMI data were slightly improved compared to last month’s, but fell within expectations, failing to provide support for the Euro. 

A jump in natural gas prices on Tuesday raised fears of a potential energy crisis in the Eurozone. EU members have recently announced a gradual ban on Russian oil imports, while Russia has retaliated by limiting its natural gas exports to certain EU countries. 

Indications that the Eurozone economy is slowing down are raising fears of a recession in the EU and putting pressure on the currency. The sluggish Eurozone economy increases the odds that the ECB may be forced to moderate its plans for raising interest rates, dragging the Euro down. Even though the ECB has pointed clearly to a shift towards a more hawkish policy, stagnating Eurozone economies limit the ECB’s flexibility to increase interest rates to combat high inflation. Eurozone inflation in June has reached a record high of 8.6%, an increase from 8.1% in May, driven primarily by rising food and energy costs. 

In its latest monetary policy meeting, the ECB kept its interest rate unchanged but pointed to a small rate hike at its next meeting in July. The Fed’s decisive 75 base point rate hike emphasized, even more, the gap between ECB and Fed policies, putting pressure on the Euro. 

The Euro has been supported these past few weeks by expectations of an ECB shift to a more hawkish direction. As the ECB announced the end of the quantitate easing program in July however, worries about high debt levels in some Eurozone countries were revived. The ECB is struggling to deal with financial fragmentation in the EU caused by the wide range of lending rates across Eurozone states, limiting the ECB’s monetary tightening options.

Several economic indicators are scheduled to be released on Wednesday for the Eurozone and may affect the Euro, especially the EU Economic Forecasts. As the ECB prepares to lift its interest rate in July, such economic data are especially important as they may help determine the level of fiscal tightening that the ECB will apply.

EURUSD 1hr chart

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GBP 

The Sterling plummeted on Tuesday, as the dollar gained strength, with the GBP/USD rate touching a two-year low. The GBP/USD pair fell below the 1.200 level support on Tuesday, trading as low as 1.190. If the GBP/USD rate goes up, it may encounter resistance near the 1.308 level, while if it declines, support may be found near 1.140. 

Several financial indicators were released on Tuesday, including Final Services PMI, BOE Financial Stability Report, FPC Meeting Minutes, and FPC Statement. UK Final Services PMI data exceeded expectations, rising to 54.3 from last month’s 53.4 but failed to provide support for the Sterling. The BOE Financial Stability Report released on Tuesday was bleak, with the Bank of England issuing a warning about the global economic recession. BOE Governor Andrew Bailey told a news conference following the release of the report, that lenders need to prepare for a ‘deteriorated economic outlook’.

Deteriorating economic health in the UK is keeping the currency down, while global recession fears are putting pressure on the risk-sensitive Sterling. Political woes in Britain continue unabated, reducing investor confidence in the Sterling. On Tuesday, UK Chancellor of the Exchequer Rishi Sunak and Health Secretary Sajid Javid announced their resignations from Boris Johnson’s government.

Britain’s uncertain economic outlook limits the BOE’s ability to shift towards a more aggressively hawkish policy. In its latest policy meeting, the BOE raised its benchmark interest rate by 25 base points, bringing its interest rate to 1.25%. By performing a modest rate hike the BOE is trying to strike a balance between battling inflation and supporting the sluggish economy. With the Fed raising its interest rate by 75 base points, the divergence in monetary policy between the Fed and the BOE becomes highlighted, putting pressure on the Sterling. 

UK inflation has risen to 40-year highs in June touching 9.1% on an annual basis. The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Soaring inflation rates add more pressure on the BOE to continue increasing its interest rates. Stagflation is a risk for the UK economy, however, as for many other countries, economic stagnation coupled with rising inflation creates a toxic mix for the economy. 

UK Construction PMI data are scheduled to be released on Wednesday and may affect the currency slightly, as these are key indicators of economic health. In addition, MPC members Pill and Cunliffe are due to deliver speeches on Wednesday, which may cause volatility in the price of the Sterling, as MPC members’ speeches can provide information about the BOE’s policy direction.

GBPUSD 1hr chart

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JPY

The Yen gained strength on Tuesday, with the USD/JPY pair retreating to 135.5, just above the 135.3 resistance level representing 2002 high. If the USD/JPY declines, support might be found near the 130.5 level and further down at the 127 level. If the pair climbs it may find resistance at the 136.7 level and further up at the 1998 high of 147.7. 

The Yen gained strength on Tuesday, outweighing the dollar’s ascend, rising on global recession fears. Oil prices retreated on Tuesday, providing relief for the economy of Japan, which is a net energy importer. Economic data released on Tuesday for the Yen were weak though, with Average Annual Cash earnings dropping to 1.0% from 1.3% last month and falling short of the 1.5% projections. 

Japan’s 10-year bond yielded 0.25 at Tuesday’s bond auction, which was higher than last month’s, but remains low, fluctuating slightly above the BOJ’s 0% goal. 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 BOJ has kept its benchmark interest rate at -0.10%, despite the rising inflation rates in Japan. The BOJ’s decision to keep its interest rate unchanged emphasizes the divergence between the BOJ’s fiscal policy and that of other major Central Banks, especially following the Fed’s 75 base point rate hike. While other countries are moving towards quantitative tightening, Japan continues to pour money into the economy and maintains its negative interest rate. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down. 

Inflation in Japan remained above the BOJ’s 2% target in June, reaching 2.1% on an annual basis. The combination of a weak currency and rising inflation is burdening Japanese households. 

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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