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Important calendar events
The dollar rallied on Thursday, as the US economy showed signs of recovery and the dollar index climbed above the 102 level. US Treasury yields also edged marginally higher, with the US 10-year bond yielding approximately 3.46%.
Advanced quarterly GDP released on Thursday 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. US unemployment data on Friday reinforced this notion, as unemployment claims dropped to 186K from 192K last week. It is as yet uncertain how the economic recovery will affect Fed rate hikes and a lot of hinges on the PCE inflation indicator on Friday. Markets reacted favorably to the release of robust economic data, however, and the dollar strengthened on Thursday.
US inflation seems to be cooling, as Producer Price Index declined by 0.5% in December, versus estimates of a 0.1% drop. US headline inflation also dropped to 6.5% year-on-year in December from 7.1% in November. Cooling price pressures may give the US Federal Reserve some leeway towards scaling back its interest rate increases, putting pressure on the dollar.
Fed interest rate increases have been the main factor driving the US dollar and treasury yields over the past few months. At the latest monetary policy meeting the Fed raised interest rates by 50 basis points, bringing the benchmark interest rate to a target range of 4.25% to 4.50%.
US economic outlook and inflation will likely determine the pace of future rate hikes. The Fed monetary policy meeting next week will likely affect the dollar considerably. Many analysts believe that the Fed will ease its rate hikes but 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. Markets however are currently pricing in a more moderate 25-bp rate hike at the Fed’s next monetary policy meeting.
As interest in the Fed’s future policy direction mounts, the dollar will be especially sensitive to FOMC members’ speeches this week. Traders will also be anticipating the release of the Core PCE Price Index on Friday, which is the Fed’s preferred inflation gauge and may influence future monetary policy.
The Euro retreated against the dollar on Thursday and EUR/USD dropped to 1.085 but pared some of its losses later in the day. If the currency pair goes up, it may encounter resistance at 1.089 and higher up near 1.118. If the EUR/USD pair declines, it may find support at 1.070.
ECB President Christine Lagarde delivered a particularly hawkish speech on Monday, emphasizing the central bank’s commitment to raising interest rates. Lagarde stated that the ECB will still have to raise interest rates significantly at a steady pace to combat soaring inflation.
Final EU headline inflation dropped to 9.2% year-on-year in December from a 10.1% print in November indicating that Eurozone inflation is cooling. This is the first drastic drop in inflation that signals that the ECB’s efforts to tame inflation are bearing fruit. Price pressures in the Eurozone remain high though, and interest rates need to rise significantly to combat entrenched inflation.
EU inflation rates are still far from the ECB’s 2% goal and are forcing the central bank to hike rates aggressively. In its latest monetary policy meeting in December, the ECB raised interest rates by 50 bp, bringing its benchmark interest rate to 2.50%. The question, however, is whether economic conditions in the Eurozone will allow the ECB to continue raising interest rates at a fast pace. EU economic outlook is poor, and the ECB might be forced to raise interest rates in a recessionary backdrop.
Markets are pricing in at least two more 50-bp rate hikes this year. On the other hand, market odds for the next Fed rate hike are at 25-bp, as a pivot in the Fed’s policy is expected. If this scenario comes true, it will boost the Euro against the dollar. Next week all eyes are going to be on the Fed and ECB monetary policy meetings, which will likely determine the trend of EUR/USD.
Minor economic activity indicators are due on Friday for the Eurozone, including French Flash GDP, French Consumer Spending, Spanish Flash GDP, M3 Money Supply, and Private Loans. Market participants will also pay close attention to ECB members’ speeches to gauge the central bank’s monetary policy direction.
The Sterling was volatile on Thursday and GBP/USD dropped to 1.234 but rallied later in the day, climbing back to 1.241. The dollar’s ascend on Thursday put pressure on the Sterling, but cooling UK inflation provided support for the pound. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.216.
BOE Governor Andrew Bailey last week appeared to be optimistic about British inflation this year, stating that that inflation looks set to fall markedly as energy prices decrease. He stressed, however, that labor shortages in the UK pose a threat to cooling inflation rates. Bailey also stated that a corner has been turned in UK inflation, appearing confident that inflation rates will continue to decline.
UK inflation data on Wednesday seemed to bare out Bailey’s optimism. PPI Input data, which is an indicator of consumer inflation, were released on Wednesday for two months, November and December. PPI Input dropped by 0.2% in November from an increase of 0.9% in October, and in December, consumer inflation cooled even further, decreasing by 1.1%. Similarly, PPI output data released for November and December showed that British manufacturers unexpectedly lowered their prices over the past two months. PPI Output printed at -0.1% in November from 0.9% in October and at -1.1% in December, suggesting that inflation may be easing. In addition, UK headline inflation dropped to 10.5% in December from 10.7% in November. Core CPI, which excludes food and energy, remained at 6.3%, against expectations of a 6.2% print.
UK inflation has become entrenched, however, remaining firmly above 10%. Surging inflation has forced the BOE to adopt a more hawkish fiscal policy, bringing its interest rate to 3.50% in December, its highest rate in 14 years. In the latest monetary policy meeting in December, BOE members voted to hike rates by 50 bps. With inflation remaining above 10%, this was perceived by many analysts as the start of a pivot toward a more dovish fiscal policy, putting pressure on the Sterling.
The UK’s grim economic outlook may limit policymakers’ ability to increase interest rates sufficiently to rein in inflation. 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. Next week, the all-important Fed and BOE monetary policy meetings will be the focus of traders’ attention and will likely affect the GBP/USD rate.
The Yen retreated against the dollar on Thursday, with USD/JPY climbing to the 130.5 level. 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 134.7.
BOJ Summary of Opinions, which includes the BOJ's projection for inflation and economic growth was released on Thursday. The summary of opinions did not show any signs of a pivot to a more hawkish policy. Most policymakers maintained the stance they held in January’s meeting, reiterating that the Bank needs to continue with the current yield curve control and ultra-easy policy. Others expressed worry about inflation levels in Japan and the feasibility of raising wages sustainably.
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 released last week for December was at 4.0%, rising above November’s 3.7% print.
Monetary Policy Meeting Minutes of the BOJ’s previous meeting in December released on Monday showed that Government Officials sought a half-hour adjournment during the meeting to contact their ministries before reaching a crucial decision on the central bank’s yield curve control policy. The BOJ caused a stir in markets in its previous meeting in December by changing its yield control target for the 10-year government bond to between plus or minus 0.50%, from a previous 0.25%. The BOJ had set a target range around zero for government bond yields for years, and this adjustment may be the signal of a shift towards a more hawkish policy. Long-term, this move may allow interest rates to rise, cutting off some of its monetary stimuli.
Japanese policymakers maintained ultra-low interest rates last week, keeping the central bank’s refinancing rate at -0.10% as expected. The BOJ was expected to relax its yield curve control policy further, but the central bank left all policy settings unchanged this month putting pressure on the Yen.
BOJ Governor Haruhiko 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. Kuroda, however, 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 final GDP Price Index for the third quarter of 2022 showed economic contraction by 0.3% on an annual basis and 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.
Tokyo Core CPI is scheduled to be released on Friday, which may provide an additional gauge of inflation in Japan and may cause some volatility in Yen price.
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Written by:
Myrsini Giannouli
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