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Dollar rally halted as market risk sentiment grows

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Written by:
Myrsini Giannouli

27 May 2022
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Important calendar events

  • EUR: M3 Money Supply, Private Loans
  • USD: FOMC Member Bullard Speaks, Core PCE Price Index, Goods Trade Balance, Revised UoM Consumer Sentiment, Revised UoM Inflation Expectations

USD

The dollar’s rally was halted on Thursday, as market risk sentiment grew. Global stock markets rose, while the dollar index fell to 101.7. Bond yields were steady on Thursday, with the US 10-year treasury note yield near the 2.7% level.

Several US economic activity indicators were released on Thursday and were overall mixed for the US economy. Preliminary GDP data were lower than expected, indicating that the US economy is still struggling to recover from the effects of the pandemic. Unemployment Claims on the other hand were lower than expected, showing that the jobs sector is moving in a positive direction.

FOMC meeting minutes released on Wednesday were in line with market expectations, re-affirming the Fed’s commitment to tackling soaring inflation in the US. The FOMC meeting minutes indicated that FOMC members are prepared for a series of rate hikes of 50 base points each, confirming that the Fed intends to move with a gradual but steady pace towards monetary policy normalization.

Disappointing economic activity data on Tuesday had pushed the dollar down, with the dollar index plummeting to 101.7. US Flash Manufacturing and Services PMI data released on Tuesday were lower than expected, hitting a four-month low, showing signs that US economic health is not advancing as anticipated. 

Last week, market sentiment was unstable, while the dollar’s high price tempted traders to close long positions, realizing their profits. The USD, which had been trading in overbought territory, softened, also weakened by the lack of support from Treasury yields. 

The dollar has been boosted by hawkish Fed policy and increased risk-aversion sentiment for the past couple of months. Continued Russian hostilities against Ukraine have increased risk-aversion sentiment, 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, although risk appetite seems to be gradually returning to markets. 

On Monday, US President Biden announced a plan of cutting China tariffs, to reduce inflation. The move increased risk sentiment, pushing the safe-haven dollar down. The Euro’s rise on Monday also put pressure on the dollar, as ECB President Christine Lagarde shifted towards a more hawkish direction, boosting the Euro.

In its latest monetary policy meeting, 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. The Fed has also announced 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 US economic activity indicators are scheduled to be released on Friday, such as the Core PCE Price Index, Goods Trade Balance, Revised UoM Consumer Sentiment, and Revised UoM Inflation Expectations. In addition, FOMC members are due to deliver speeches on Friday, which may cause some volatility in the price of the dollar.

TRADE USD PAIRS

EUR 

The Euro gained strength against the dollar on Thursday, as the dollar weakened, with the EUR/USD climbing to the 1.073 level. If the currency pair goes up, it may encounter resistance at 1.093. If the currency pair falls, it may encounter support at the 1.036 level that represents the 2016 low, and further down near a 20-year low of 0.985.

Increased market risk sentiment on Thursday pushed the dollar down in favor of riskier assets. On Wednesday, several financial indicators were released for Germany, which is the Eurozone’s leading economy, and were mostly negative for the state of the economy in Germany, driving the Euro down. The ECB Financial Stability Review was published on Wednesday, putting more pressure on the currency, as the report indicated that economic conditions in the EU have deteriorated, with rising Eurozone and slow post-Covid economic recovery.

ECB President Christine Lagarde delivered a speech on Wednesday at the World Economic Forum in Davos. Lagarde’s speech was hawkish, emphasizing the need for a rate hike in the ECB’s next monetary policy meeting in July, with other ECB members firmly supporting an increase in the EU Central Bank’s interest rates.  

Disappointing EU economic data held the Euro down on Tuesday, even as the dollar weakened. Flash Manufacturing and Services PMI data were released on Tuesday for France and Germany, which are among the EU’s leading economies, and for the Eurozone as a whole. PMI data are indicators of economic health and, overall, the data were mixed and mostly fell below expectations, showing that economic activity in the EU is not advancing as anticipated. 

Increased risk-aversion sentiment and hawkish Fed policy have been boosting the dollar these past few weeks at the expense of other currencies, with the Euro suffering heavy losses. The dollar, which had been moving in overbought territory, has been slipping since last week, as market risk appetite begins to recover. 

On Monday, economic data on German business morale were positive for the Eurozone’s leading economy, boosting the Euro. ECB President Christine Lagarde posted an uncharacteristically hawkish statement on Monday. Lagarde pointed to rate hikes in Q3 of this year, which would bring the ECB’s interest rate at least to zero and possibly to positive territory. 

Clear indications from the ECB that it would move towards a more hawkish policy this year, have boosted the Euro. Markets are now pricing in up to 105 base points rate hikes throughout the year. 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. The US Federal Reserve has raised its benchmark interest rate by 50 base points to 1%, highlighting the difference in monetary policy between the EU and the US and has been driving the Euro down. 

Last month, headline inflation in the Eurozone was slightly lower than expected, reaching 7.4% in April, while core CPI was at 3.5%. Investors were expecting higher EU inflation rates for April, as increasing energy costs are augmenting inflationary pressures.

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

The sterling traded sideways against the dollar on Thursday, with the GBP/USD rate fluctuating around the 1.26 level. If the GBP/USD rate goes up, it may encounter resistance at the 1.263 level and further up near the 1.308 level, while if it declines, support may be found near the two-year low at 1.206. 

On Thursday, the dollar dipped on increased market risk sentiment, although the sterling failed to take advantage of the dollar’s decline. On Tuesday, UK Flash Manufacturing and Services PMI data fell considerably below expectations, weakening the sterling. PMI data are strong indicators of economic health and revealed that economic activity in the UK is not recovering from the pandemic as anticipated.

The sterling had rallied in the past week, supported by a weakening dollar and positive UK economic data. The dollar has been pushed down from its 20-year highs due to a combination of unstable market sentiment and probable profit-taking on long positions. Other assets have profited from the dollar’s weakness, although risk-aversion sentiment remains high, checking the sterling’s advance. 

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. In its latest monetary policy meeting, the Bank of England raised its benchmark interest rate by 25 base points, bringing its rate to a 13-year high of 1%. 

Headline inflation in the UK rose to 9% in April, while core inflation hit 6.2%. Headline inflation reached a new 40-year high, highlighting the need for legislative action to tame soaring inflation rates. 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.

GBPUSD 1hr chart

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JPY

The Yen gained strength early on Thursday, on positive economic data for Japan. The currency pared its gains later in the day though, as increased risk sentiment pushed both the dollar and the Yen down. The USD/JPY pair fluctuated around the 127 level on Thursday. If USD/JPY rises, it may find resistance at 129.7 and further up at 131.35. If the USD/JPY declines, support might be found near the 127 level and further down at the 121.3 level. 

BOJ Governor Haruhiko Kuroda delivered a speech on Wednesday at a conference hosted by the Bank of Japan in Tokyo. Kuroda stressed the challenges created by rising global inflation rates, although he showed no signs of considering a change in the BOJ’s ultra-easy monetary policy.

Flash Manufacturing PMI and Annual BOJ Core CPI data were released on Tuesday and were mixed for the state of the economy in Japan. PMI data were disappointing, showing that the Japanese economy is not recovering as expected. CPI data, on the other hand, exceeded expectations, indicating that inflation rates in Japan are rising and boosting the Yen. 

The Yen has been oversold over the past few months and began gaining some traction last week, attracting market attention as a safer investment. The dollar is also a safe-haven currency but has been trading in overbought territory and has been slipping. On Monday however, increased risk sentiment put pressure on both currencies.

The Yen has been retreating for months, with market interest in the currency slowing down, despite global economic risks. The currency, which has been oversold, regained some of its lost ground at the end of last week, but the outlook for the USD/JPY pair remains bullish.

Bond yields have fallen across Japan’s treasury curve due to low demand. Japan’s 10-year government bond yield auction maintained the 0.25% interest rate as 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 nearly 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 and maintains its negative interest rate. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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