Important calendar events
The dollar was firm on Tuesday, with the dollar index remaining close to 103.5 most of the day. US Treasury yields gained strength on Tuesday, with the US 10-year bond rising to 3.67%.
On Tuesday, Fed Chair Jerome Powell confirmed that the disinflation process has begun but emphasized that it still has a long way to go. Powell’s speech on Tuesday was cautious, reinforcing the notion that the Fed’s decisions will be based strongly on disinflation rates and the state of the US economy. The dollar was volatile during Powell’s speech, dropping sharply at the mention of disinflation, but rallying soon afterward.
After a series of aggressive rate hikes last year, the Fed has finally decided to relax its hawkish policy. The Federal Reserve raised interest rates by only 25 basis points last week, bringing the benchmark interest rate to a target range of 4.50% to 4.75%. A pivot towards a more dovish policy was expected by markets, however, and had been largely priced in.
Fed Chair Jerome Powell, at his press conference after the conclusion of the meeting defended the central bank’s decision to relax its hawkish policy. Powell caused a stir in markets, expressing himself as satisfied with the ‘disinflation’ process. Powell emphasized that ongoing rate hikes are appropriate since substantial evidence is necessary that inflation is under control.
Market response to last week’s Fed meeting outcome was delayed. The initial market response was negative for the dollar, and the currency plummeted. In the past few days, markets began to weigh in on the implications of the Fed’s decisions and the dollar rebounded.
Many analysts believe that the Fed 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. Rate hikes have become less aggressive, but the Fed might continue raising interest rates for longer than previously expected.
US inflation seems to be cooling, as US headline inflation also dropped to 6.5% year-on-year in December from 7.1% in November. Cooling price pressures have given the US Federal Reserve some leeway towards scaling back its interest rate increases, putting pressure on the dollar.
Advanced quarterly GDP data revealed that the US economy is expanding at a higher rate than anticipated. US GDP for Q4 of 2022 grew by 2.9% against expectations of a 2.6% growth. The US is likely headed for an economic ‘soft landing’ and recession concerns ease.
Minor fundamentals are due on Wednesday for the US, including, Final Wholesale Inventories and 10-y Bond Auction.
This week, the dollar’s direction is expected to depend largely on Fed rhetoric. FOMC Member Williams is due to deliver a speech on Wednesday, which may affect the dollar.
The Euro traded sideways against the dollar on Tuesday, with EUR/USD oscillating around the 1.072 level. If the currency pair goes up, it may encounter resistance near 1.103. If the EUR/USD pair declines, it may find support at 1.048.
Eurozone fundamentals on Tuesday were mostly negative for the EU economic outlook. German Industrial Production shrank 3.1% in December, against expectations of a 0.7% drop. French Trade Balance printed at -14.9B in December, versus -12.1B expected.
The ECB meeting raised interest rates by another 50 bp last week, bringing its main refinancing rate to 3.0%. The rate hike was in line with market expectations though and had already been priced in.
ECB President Christine Lagarde gave a press conference with hawkish undertones after last week’s ECB meeting. Lagarde emphasized that the central bank aims to bring inflation down to its 2% target. Lagarde confirmed that another 50-bp rate hike would follow at the next monetary policy meeting in March, after which the ECB would re-evaluate its policy. Market odds are currently favoring an increase of the ECB refinancing rate to 4.0% by June. Even though the ECB seems prepared to continue raising interest rates to bring inflation down, the market response was negative towards the Euro, which plummeted.
EU inflation rates are decreasing, but they are still far from the ECB’s 2% goal and are forcing the central bank to hike rates aggressively. Final EU headline inflation dropped to 8.5% year-on-year in January from a 9.2% print in December, indicating that Eurozone inflation is cooling. The continued drop in inflation signals that the ECB’s efforts to tame inflation bear fruit. Price pressures in the Eurozone remain high though, and interest rates need to rise significantly to combat entrenched inflation.
Only minor fundamentals are scheduled to be released on Wednesday for the Eurozone, including, French Preliminary Private Payrolls and Italian Retail Sales.
The Sterling hit a new 1-month low against the dollar in early trading on Tuesday but edged higher later on and GBP/USD rose to 1.204. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while further support may be found near 1.284.
The Halifax HPI index on Tuesday exceeded expectations, providing support for the Sterling. This is a housing index, representing the change in the price of homes. The Halifax HPI in January was flat, against expectations of a 0.8% drop.
The Sterling has been under pressure since last week, as the outcome of the BOE monetary policy meeting was perceived by markets as dovish. The BOE raised interest rates by another 50 bp last week, bringing the official bank rate to 4.0%. The rate hike fell in line with market expectations and had already been priced in.
The BOE Monetary Policy Report issued after the meeting, however, was more dovish than expected, pointing to a possible pause in rate hikes. The policy report stated that “if there are more persistent price pressures then only will further tightening be required”.
Inflation data have shown that inflation in the UK is cooling. UK headline inflation dropped to 10.5% in December from 10.7% in November. With inflation remaining firmly above 10% though, additional measures would be required to bring price pressures down.
The UK’s grim economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The IMF downgraded the UK’s growth forecast, predicting that the British economy will contract by 0.6% this year. 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.
The Yen recovered a little on Tuesday, after plummeting last week. The USD/JPY edged lower on Tuesday, touching the 130.6 level. Currently, the USD/JPY rate is driven primarily by the dollar’s direction, as markets weigh in on the implications of the Fed’s dovish shift. 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 131.6.
Economic activity and health data released on Tuesday for Japan were rather contradictory and failed to provide support for the Yen. Wages increased in Japan for the first time in nine months. Average Cash Earnings increased by 4.8% year-on-year in December, against expectations of a 2.5% raise. Interestingly enough, household spending on an annual basis in December contracted by 1.3%, versus a 0.3% drop expected.
The Yen came under pressure this week, as rumors surfaced regarding the successor of BOJ Governor Haruhiko Kuroda. Kuroda 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 Japanese Government has reportedly approached Deputy BOJ Governor Masayoshi Amamiya for the position of BOJ Governor, although Japanese government officials have since denied this. Amamiya is also a firm supporter of the central bank’s ultra-loose monetary policy, though. A change in leadership with Amamiya at the helm would probably make little difference to BOJ policy. Market reaction reflected this eventuality, and the Yen tumbled after the rumors surfaced.
Japanese policymakers maintained ultra-low interest rates at the BOJ’s January meeting, keeping the central bank’s refinancing rate at -0.10% as expected. BOJ Governor 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.
BOJ Core CPI rose to 3.1% year-on-year, exceeding expectations of a 2.9% print. Inflation in Japan has gone above the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households. National Core CPI for December was at 4.0%, rising above November’s 3.7% print.
The final GDP Price Index for the third quarter of 2022 showed an economic contraction of 0.3% on an annual basis. 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.
On the data front, several indicators of economic health are scheduled to be released on Wednesday for Japan, including, Bank Lending, Current Account, and Economy Watchers Sentiment. These may affect the Yen price somewhat, although USD/JPY is expected to depend primarily on the dollar this week.
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