Important calendar events
The dollar gained strength on Tuesday, with the dollar index climbing back to 104.5. US Bond yields remained high, with the US 10-year treasury note yielding approximately 3.2 on Tuesday.
US Consumer Confidence and Richmond Manufacturing data released on Tuesday fell below expectations. Weak economic data indicate that the US economy is struggling, pushing the dollar down.
Increased risk aversion sentiment however favored the safe-haven dollar, boosting its price. The G7 leaders decided on Tuesday to take further action against Russia, by imposing “severe and immediate economic costs” on Russia.
Deteriorating economic health in the US is raising recession concerns 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.
US inflation keeps rising, forcing the Fed to tighten its monetary policy. PPI climbed 0.8% for the month and 10.8% on an annual basis, falling close to the historically high levels reached in March. CPI in May increased by 8.6% on an annual basis, the largest year-on-year increase since 1981 according to the US Labour Department. Rising costs of food and energy have contributed to soaring inflation rates in the US.
Important US economic indicators are expected to be released on Wednesday, including the Final quarterly GDP. In addition, FOMC Member Mester and Fed Chair Powell are due to deliver speeches on Wednesday, which are likely to affect the dollar.
The Euro plummeted on Tuesday, as the dollar gained strength, with the EUR/USD rate falling to the 1.052 level. 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 1.036 level that represents 2016 low and further down at the 20-year low of 0.985.
German GfK Consumer Climate data released on Tuesday were in line with expectations. In addition, ECB President Christine Lagarde delivered a speech on Tuesday at the ECB Forum on Central Banking, in Portugal, which was more hawkish than expected. In her speech, Lagarde downplayed EU recession risks and emphasized the ECB’s commitment to battling inflation. Even though Lagarde stated that the ECB is ready to raise its interest rate at a faster pace, the Euro continued to decline, as markets have already priced in several rate hikes this year.
Indications that the Eurozone economy is slowing down are raising fears of a recession in the EU. The sluggish Eurozone economy increases the odds that the ECB may be forced to moderate its plans for raising interest rates, driving 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.
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 ECB has kept its interest rates below zero for over a decade and an increase in interest rates represents a hawkish turn in its monetary policy, to counter unprecedented inflation rates.
EU inflation remains at record high levels of 8.1%, driven by rising food and energy costs. 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, raising fears of a potential energy crisis in the EU.
This week, the ECB summit in Portugal is expected to draw the attention of market participants, and announcements from ECB officials throughout the event may affect the Euro price. ECB President Christine Lagarde will participate in a panel discussion at the ECB Forum on Central Banking on Wednesday, along with BOE Governor Andrew Bailey and Fed Chair Powell. High volatility is expected during the panel discussion, not only for the Euro but for the dollar and the Sterling as well.
The Sterling plummeted on Tuesday, pressured by Brexit woes and the unstable political climate in the UK. The dollar rallied on the other hand, with the GBP/USD rate crashing to the 1.218 level. 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 1.200 and further down near 1.140.
British Prime Minister Boris Johnson aims to pass legislation through parliament this year to scrap some of the rules on post-Brexit trade with Northern Ireland. Political woes are also holding the Sterling back, as the Tories suffered defeat in two UK by-elections, with the ruling party losing two seats in the parliament.
Deteriorating economic health in the UK is raising fears of recession, putting pressure on the Sterling. 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 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.
BOE Governor Andrew Bailey is due to deliver a speech on Wednesday in a panel discussion titled "Policy panel" at the ECB Forum on Central Banking and his speech may cause volatility in the price of the Sterling.
The Yen retreated against the dollar on Tuesday, with the USD/JPY pair breaking through the 135.3 level resistance representing the 2002 high, and climbing to 136.3. 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 near 136.7 and further up at the 1998 high of 147.7.
BOJ Core CPI data were released on Tuesday, which is key inflation indicators. The BOJ Core annual CPI was at 1.5%, which was in line with expectations and did not have a significant impact on the price of the Yen.
The dollar rallied on Tuesday on increased risk aversion sentiment, decreasing the competing Yen’s appeal. Oil prices also climbed on Tuesday, pushing the Yen down. Japan is a net importer of oil and high oil prices have been putting pressure on the country’s economy.
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.
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.
Inflation in Japan remains above the BOJ’s 2% target, reaching 2.1% on an annual basis for the second month. The combination of a weak currency and rising inflation is burdening Japanese households.
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