Important calendar events
The dollar recovered its losses on Thursday, as markets had time to absorb Wednesday’s Fed statement, with the dollar index jumping again to the 20-year record of 103.9. The US dollar has been rising these past few weeks, surpassing its pandemic high of 2020 and reaching a 103.9, supported by high Fed rate hike expectations, which led to market disappointment after Fed’s less hawkish than an anticipated announcement. US yields also recovered on Thursday, with the US 10-year treasury note reaching 3.1% once more.
Over the past few weeks, Fed rhetoric has been one of the primary drivers of USD price, as the Fed signaled a faster pace of policy tightening in the US. The outcome of the highly-anticipated Fed meeting on Wednesday disappointed expectations, however, leading to the dollar’s decline. On Thursday the dollar rallied, as markets had time to assess the Fed policy news, but also as a strong risk-off sentiment prevailed. Stock markets crashed, with the Dow falling by more than 1,000 points.
The US Federal Reserve raised its benchmark interest rate by 50 base points to 1%, on Wednesday. This is the first time that the Fed has performed such a steep rate hike since 2000. A rate hike of 50 bp, however, had been fully priced in by markets and some market participants were even anticipating a 75 bp rate hike. Markets have been pricing in a total of over 225 base points of additional interest rate hikes this year, with the main Fed rate expected to rise to 2.75%.
More importantly, the ensuing Fed statement was less hawkish than anticipated, with Fed Chair Jerome Powell stating firmly that the Fed is now considering a 75 bs rate hike for the next policy meetings. The Fed’s statement disappointed market expectations, driving the dollar down.
In addition, the Fed’s announced on Wednesday 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 many the US Central Bank to address has decided to start trimming its balance sheet.
Continued Russian hostilities against Ukraine have increased risk-aversion sentiment these past two months, providing support for the safe-haven dollar. The situation between Russia and Ukraine continues to escalate, as Russian President Vladimir Putin makes threats about using nuclear weapons, while he cuts off the gas supply to Poland and Bulgaria.
Several financial and employment indicators are scheduled to be released for the US on Friday, including Average Hourly Earnings, Non-Farm Employment Change, and Unemployment Rate. FOMC Member Williams is also due to deliver a speech on Friday, which may cause some volatility for the dollar, in the wake of Wednesday’s Fed meeting.
The Euro has been under pressure by the rising dollar these past few weeks, with the EUR/USD rate trading near the 1.050 level, below a five-year low. On Wednesday however, the currency pair was catapulted to 1.063, following the Fed’s statement that saw the dollar plummet to a one-week low. The Euro pared its gains on Thursday, with the EUR/USD pair falling back to the 1.050 level. If the currency pair falls even further, it may find support near the 2016 low around the 1.036 level. The outlook for the pair is still bearish as markets will have time to absorb the Fed’s announcement in the following days, but if the currency pair goes up, it may encounter resistance at 1.118.
Increased risk-aversion sentiment and hawkish Fed policy have boosted the dollar at the expense of other currencies, with the Euro suffering heavy losses these past few weeks.
The 10-year German Bund yield has risen to 1% this week, for the first time in eight years, as expectations that the ECB will need to increase rates continue to grow. Ecofin and Eurogroup meetings were also held this week, at which the direction of the Eurozone economy was discussed.
Eurozone CPI flash inflation estimates have risen by 7.5% on an annual basis, highlighting the problem of rising energy and commodity prices in the EU. Core CPI estimates rose to 3.5%, further increasing the likelihood of an ECB rate hike in July. Markets are pricing in 3 ECB rate hikes this year, of at least 25 base points each.
The ECB however, has so far been hesitant to raise its interest rates, as the Eurozone economy is still struggling to recover from the effects of the pandemic. The ECB is trying to avert a dangerous economic effect known as stagflation, the mix of economic stagnation and high inflation rates. As the Fed is expected to raise its benchmark interest rate significantly at its policy meeting this week, the Euro remains at a disadvantage from the difference in interest rates.
Many of the Central Bank’s members have repeatedly expressed concern about the high inflation levels in the EU and are in favor of taking immediate steps towards monetary policy normalization. ECB President Christine Lagarde is in favor of a more dovish stance, however, and has stated that Eurozone inflation is expected to rise in the following months, while economic growth is expected to stall. Even Lagarde however, has shown recent signs of wavering though, as rising inflationary pressures are forcing the ECB to act to drive inflation down. Last week, Lagarde delivered a speech that was considered more hawkish than expected, stressing that the ECB will be following a different route than the Fed, but leaving the door open for a rate hike in July.
The sterling has been under pressure for the past few weeks, falling against the dollar, with the GBP/USD rate falling as low as 1.240 last week. The GBP/USD rate was catapulted to 1.264 on Wednesday though, following the Fed monetary policy meeting. On Thursday, the pound plummeted to new lows, following the BOE’s interest rate announcement, with the GBP/USD pair falling to 1.232. If the GBP/USD rate goes up, it may encounter resistance at the 1.331 level and further up near the 1.341 level, while if it declines, support may be found at 1.241 and further down near the two-year low at 1.206.
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.
The Official BOE interest rate was announced on Thursday, just a day after the Fed announced that it would raise its benchmark interest rate by 50 base points. In a widely expected move, the Bank of England raised its benchmark interest rate on Thursday by 25 base points, although three of its members voted for a more aggressive rate hike of 50 bp. The BOE had already performed three consecutive rate hikes in its previous meetings, bringing its rate to a 13-year high of 1%. The sterling plummeted after the announcement of the BOE’s baseline interest rate, as the rate hike had been fully priced in and some market participants were anticipating an even steeper rate hike. Markets have already priced in approximately six BOE rate hikes this year, but it remains to be seen whether these expectations will be fulfilled.
On Thursday, the BOE statement stressed once more the dangers of recession, as the economic contraction is battling with inflation rates that are predicted to surge to 40-year highs of 10% in the coming months. The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Rising commodity prices and import costs in the UK are driving inflation rates higher, with headline inflation reaching 7% and climbing.
BOE Governor Andrew Bailey has recently stated that the BOE is walking a tight line between inflation and economic recession and warned of the risks of tightening monetary policy too fast. Recent economic data show that the British economy is sluggish and economic recovery is still a long way off.
In this week’s BOE and Fed meetings, we are starting to see a divergence between Fed and BOE policies, with the Fed moving towards a more aggressive economic tightening by raising its interest rate by 50 bp, versus the 25 bp of BOE’s interest raise. The difference between the Fed’s and the BOE’s stance over the past few weeks has been driving the sterling down and propping up the dollar, with most market participants becoming more modest in their expectations of a BOE rate hike. Even though the Fed disappointed market expectations of a higher rate hike on Wednesday, investors still see the Fed adopting a more decisive approach towards tackling rising inflation rates than the more hesitant BOE. Interestingly enough, both Central Banks have now brought their interest rates to the same level of 1%, but the BOE is perceived to be slowing down, while the Fed is moving with a more aggressive pace.
MPC Members Mann, Pill, and Tenreyro are due to deliver speeches on Friday. Their speeches may cause some volatility for the sterling as they may provide insight into the BOE’s future monetary policy direction.
The USD/JPY rose again on Thursday, climbing to 130.5 in the wake of the Fed policy meeting. The Yen had plummeted to a 20-year low last week, following the BOJ’s latest monetary policy meeting, with the USD/JPY trading above 131, its highest price in 20 years. If USD/JPY resumes its ascend, it may find resistance at the 2002 high of 135.3. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level.
The primary driver of the Yen over the past few months has been the BOJ’s fiscal policy. Last week, the Yen has been pushed down by the persistently dovish stance of the BOJ. Bank of Japan officials acknowledge the impact on the Japanese economy from increased import costs due to the weak yen but persist in 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.
The BOJ announced its main interest rate last Thursday and released an outlook report, detailing the factors that shape its monetary policy. The Bank of Japan continued its ultra-accommodating policy and massive stimulus program. The BOJ also maintained its negative interest rate of -0.10%, in contrast to other Central Banks, which are moving towards a policy normalization after the pandemic and are raising their benchmark interest rates. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.
The BOJ released a press conference after the conclusion of the meeting, with BOJ Governor Haruhiko Kuroda issuing a dovish statement that pushed the Yen to record lows. Kuroda vowed to continue the bank’s ultra-easy monetary policy, stating that the weakening Yen is not part of the BOJ’s considerations.
The BOJ also stated that it would continue to buy an unlimited amount of Japanese treasury bonds, defending their current low yield. Japan’s 10-year government bond yield is currently close to 0.25%, more than an order of magnitude lower than the respective US 10-year bond, which is offered with a yield close to 2.8%. The large divergence in bond yields makes the low-yielding Yen less appealing to investors than the dollar, pushing its price further down.
The safe-haven dollar is boosted by continuing Russian hostilities against Ukraine. The Yen is also considered a safe-haven currency but has been underperforming, despite an increased risk-aversion sentiment, and many investors have been doubting its safe-haven status.
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