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Dollar rebounds after a slump

Home >  Daily Market Digest >  Dollar rebounds after a slump

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Written by:
Myrsini Giannouli

17 January 2023
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Important calendar events

  • EUR: German Final CPI, German ZEW Economic Sentiment, ZEW Economic Sentiment, ECOFIN Meetings
  • GBP: Claimant Count Change, Average Earnings Index, Unemployment Rate
  • USD: Empire State Manufacturing Index

USD

The dollar plummeted last week after the release of the highly-anticipated US inflation report. The dollar extended losses in early trading on Monday, with the dollar index retreating to 101.8, but rallied later in the day, rising above 102.5. 

US Treasury yields remained unchanged on Monday, with the US 10-year bond yielding approximately 3.5%. Monday was a Bank holiday in the US for Martin Luther King Day and no fundamentals were released for the dollar.

US inflation seems to be cooling, as US headline inflation dropped to 6.5% year-on-year in December from 7.1% in November. The soft inflation print put pressure on the dollar, as cooling price pressures may give the US Federal Reserve some leeway towards scaling back its interest rate increases. 

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. 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.

Global recession concerns remain high, boosting the dollar. US GDP data revealed that GDP rose by 3.2% for the third quarter of 2022. The US economy is still expanding, but at a slower pace than anticipated and recession looms.

The Empire State Manufacturing Index is scheduled to be released on Tuesday for the US, which is a major indicator of economic activity. As interest in the Fed’s future policy direction mounts, the dollar will also be especially sensitive to FOMC members’ speeches this week.

TRADE USD PAIRS

EUR 

The Euro rose to a nine-month peak against the dollar in early trading on Monday but retreated later in the day. EUR/USD climbed to 1.087 but pared gains later in the day, dropping to 1.081. If the currency pair goes up, it may encounter resistance at 1.118. If the EUR/USD pair declines, it may find support at 1.048. 

Minor economic activity indicators were released on Monday for the Eurozone, including German WPI and French Gov Budget Balance. These were overall negative for the EU economic outlook, putting pressure on the Euro.

Increased price pressures combined with a weak economic outlook have brought stagflation in the Eurozone, a toxic mix of high inflation and stale economic growth. 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. The ECB has updated its economic growth forecast by 3.4% in 2022, 0.5% in 2023, 1.9% in 2024, and 1.8% in 2025. These are lower than previous estimates, indicating that Eurozone economic outlook is poor and that 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 in February and March 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. 

Several economic activity indicators are scheduled to be released on Tuesday for the Eurozone, including, German Final CPI, German ZEW Economic Sentiment, and ZEW Economic Sentiment The outcome of ECOFIN Meetings on Tuesday may also affect the Euro. 

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

The Sterling was volatile on Monday, gaining strength early in the day but retreating later on, as the dollar rebounded. GBP/USD edged higher climbing to 1.228 in early trading but dropping to 1.218 later in the day. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.184. 

On Monday, BOE Governor Andrew Bailey delivered a speech that was perceived as dovish by markets, putting pressure on the Sterling. Bailey was 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. 

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. After a year of fiscal tightening, UK headline inflation finally dropped to 10.7% in November, alleviating some of the pressure on the BOE to raise interest rates. 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 BOE gave uncertain forward guidance at its latest policy meeting in December, leaving the door open for further rate hikes, but signaling that interest rate increases might pause within the first quarter of 2023. The UK’s grim economic outlook may limit policymakers’ ability to increase interest rates sufficiently to rein in inflation.

The British economy expanded in November, albeit only by 0.1%. Analysts were predicting a 0.2% contraction though and the unexpected rise improved the British economic outlook. The British economy remains constrained, however, and the country is on the brink of recession. 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. 

On the data front, several economic activity indicators are scheduled to be released on Tuesday for the UK. These include Claimant Count Change, Average Earnings Index, and Unemployment Rate and may cause some volatility in the Sterling price. 

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen’s ascent was halted on Monday and USD/JPY climbed back to 128.8. 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 138.2.

Price pressures continue to rise in Japan, as Year-on-year PPI to the end of December came in at 10.2% on Monday, exceeding expectations of a 9.5% print. In addition, BOJ CPI recently rose to 2.9%, mainly due to the high cost of imported energy. Inflation in Japan has gone above the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households.

The BOJ caused a stir in markets in December by finally yielding to increased price pressures and tilting its monetary policy. In the latest monetary policy meeting, Japanese policymakers maintained the central bank’s refinancing rate at -0.10% but changed its yield control target for its 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. 

Meanwhile, BOJ Governor Haruhiko Kuroda has been reaffirming the central bank’s commitment to its ultra-easy policy. 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.

Market expectations of a gradual shift in the BOJ’s policy towards a more dovish direction bolstered the Yen last week. This week, the BOJ monetary policy meeting on the 18th is expected to generate some volatility in Yen price. The BOJ is not expected to change its interest rate yet, but even subtle signs of a pivot in the bank’s policy are likely to affect the Yen. The BOJ may start moving away from its ultra-loose monetary policy by revising Yield Curve Control measures as early as this week. Market participants will be focusing on the Monetary Policy Statement and Press Conference following the meeting for any tweaks in the BOJ’s forward guidance. 

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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