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Dollar retreats from 40-year high

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Written by:
Myrsini Giannouli

19 July 2022
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Important calendar events

  • GBP: Average Earnings Index, Claimant Count Change, Unemployment Rate, BOE Governor Bailey Speech
  • EUR: EU Final CPI and Core CPI
  • USD: Building Permits, Housing Starts, FOMC Member Brainard Speech

USD

The dollar spiked last week, boosted by soaring US inflation rates, with the dollar index rising above 109.2 and setting a fresh 20-year high. The dollar retreated on Monday, as it had been trading in the overbought territory last week and the dollar index fell to the 107 level. US Bond yields remained strong on Monday, with the US 10-year treasury note yielding approximately 3%.

The global economic outlook is poor, with a recession threatening many countries. Rampant inflation, combined with tightening monetary policy creates a toxic economic mix. Recession fears and geopolitical risks increase risk aversion sentiment, boosting the safe-haven dollar. 

US economic outlook seems to be improving, while inflation rates continue to rise. Soaring US inflation rates last week boosted the dollar. US inflation in June hit a 40-year high of 9.1% on an annual basis, increasing the chances of a steep Fed rate hike this month. 

High US inflation rates are forcing the Fed to tighten its monetary policy. Another rate hike of 75 base points is expected for July and is already been priced in by markets and even a 100 bps rate hike was anticipated last week by several market participants. This week, however, markets are keeping a moderate stance. Markets are trimming rate hike bets following less hawkish Fed rhetoric late last week, with odds in favor of a 75 bps rate hike at the next Fed policy meeting next week,

Several minor US financial indicators are scheduled to be released on Tuesday. In addition, FOMC Member Brainard is due to deliver a speech at the Federal Reserve Bank of Minneapolis Centre for Indian Country Development. Her speech may cause some volatility in dollar price, as market participants will be paying special attention to Fed rhetoric ahead of the monetary policy meeting next week.

TRADE USD PAIRS

EUR 

The Euro gained strength against the dollar on Monday, with the EUR/USD rate rising to 1.018. If the currency pair goes up, it may encounter resistance at 1.050 and further up at 1.078. If the EUR/USD continues to fall past the parity level, it may find support near the 20-year low of 0.985. 

The EUR/USD pair briefly breached the parity level last week for the first time in 20 years, before paring some of its losses and climbing back above the parity level at the end of last week.

Increasing signs that the Eurozone economy is slowing down and may tip into recession have pushed the single currency down. Struggling Eurozone economies, rampant inflation, and a looming energy crisis in the EU create a toxic combination. Eurozone inflation in June has reached a record high of 8.6%, an increase from 8.1% in May, driven primarily by rising food and energy costs. Stagnating the Eurozone economy increases the odds that the ECB may be forced to moderate its plans for raising interest rates to combat high inflation. 

Concerns of an imminent energy crisis in the Eurozone also keep the Euro down, as Russia is limiting its natural gas exports to certain EU countries. Last week, Nord Stream 1, Germany’s biggest gas pipeline, was shut off for routine maintenance, which may provide an excuse to cut off completely gas supplies from this pipeline. Moreover, Gazprom announced on Monday that it could not guarantee gas supplies to certain countries, due to ‘extraordinary’ circumstances, further exasperating the EU’s energy crisis.

Political turmoil in Italy is also adding pressure on the Euro. Last week, the ruling coalition in Italy fell apart and Prime Minister Mario Draghi offered his resignation, although Italian President Sergio Mattarella did not accept Draghi’s resignation.

This week, the eagerly-awaited ECB Policy meeting on the 21st will determine the Euro’s future direction. The ECB is expected to raise its benchmark interest rate this week for the first time since 2011. A rate hike of 25 base points is widely expected, which would still keep the ECB rate in negative territory, from -0.50% to -0.25%. 

Markets have already priced in a 25 bps ECB rate hike this week, and if, market expectations are fulfilled, it is doubtful whether a modest rate hike will provide any support for the Euro. In contrast, a Fed rate hike of at least 75 bps this month is priced in by markets, emphasizing the gap between ECB and Fed policies, and putting pressure on the Euro. 

The ECB is also likely to detail its plan to deal with fragmentation in the Eurozone at Thursday’s meeting. There are dissenting voices within the ECB on the anti-fragmentation tool that is being prepared to balance out economic differences caused by the wide range of lending rates across Eurozone states.

EU Final CPI and Core CPI data are scheduled to be released on Tuesday and may affect the Euro ahead of the ECB meeting on Thursday, as they are key indicators of consumer inflation.

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

The Sterling rallied on Monday, as the dollar weakened, with the GBP/USD rate climbing to 1.202. If the GBP/USD rate goes up, it may encounter resistance near the 1.219 level, while if it declines, support may be found near 1.140. 

Renewed risk-aversion sentiment and soaring US inflation rates boosted the dollar last week, driving down competing currencies. The dollar started the week low, however, propping up the Sterling.

Britain’s uncertain economic outlook limits the BOE’s ability to shift towards a more aggressively hawkish policy. Stagflation is a risk for the UK economy, as soaring inflation rates add more pressure to the BOE to continue increasing its interest rates. UK inflation has risen to 40-year highs in June touching 9.1% on an annual basis, driven primarily by the high cost of energy imports, putting pressure on UK households.

The BOE is adopting a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. The Fed, on the other hand, is moving at an aggressively hawkish pace, spurred by soaring US inflation rates. A Fed rate hike of at least 75 bps this month is priced in by markets, highlighting the divergence in monetary policy between the Fed and the BOE and putting pressure on the Sterling. 

Political instability in the UK is also putting pressure on the pound, after British PM Boris Johnson’s resignation. As the matter of his succession will have to be decided soon, there is renewed political uncertainty adding pressure on the Sterling. 

Several economic indicators are scheduled to be released on Tuesday for the UK, such as the Average Earnings Index, Claimant Count Change, and Unemployment Rate. 

In addition, Bank of England Governor Andrew Bailey is due to deliver a speech on Tuesday, which may cause volatility in the price of the Sterling. Political turmoil in the UK is also expected to affect the currency, as developments on the subject of Boris’ succession are expected within the week. 

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen regained some of its lost ground on Monday, as the dollar weakened. The USD/JPY pair fell to nearly 138.2, after rising to the 139-level last week for the first time since August 1998. If the USD/JPY declines, support might be found near the 134.2 level and further down at 131.7. If the pair climbs it may find resistance near 139.4 and further up at the 1998 high of 147.7. 

Rising global recession fears have sparked a risk-aversion sentiment, boosting safe-haven assets. The dollar has been outperforming competing currencies, however, such as the Yen. Investors shy away from riskier assets, opting for the safety of the US currency. Even the Yen which has been traditionally considered a safe-haven currency is retreating heavily this year and is considered by many traders to be losing its safe-haven status. 

Inflation in Japan remained above the BOJ’s 2% target last month, reaching 2.1% on an annual basis, and is expected to rise even further this month. National Core CPI for Japan is going to be released on the 22nd, and it is estimated that inflation in Japan will climb above 2.2%. The combination of a weak currency and rising inflation is burdening Japanese households. 

The main event that is likely to draw the attention of JPY traders this week is the BOJ policy meeting on the 21st. The BOJ is going to announce its main refinancing rate and issue a statement describing its fiscal policy.  So far, the BOJ has kept its benchmark interest rate unchanged and is expected to maintain its negative interest rate at this week’s meeting. Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. 

The Fed is expected to raise its interest rates again considerably this month to tackle skyrocketing US inflation, with a 75 bps Fed rate hike being priced in by markets. Other major Central Banks are also tightening their monetary policy, with the ECB expected to raise its interest rate by 25 bps this week. The difference in interest rates with other major Central Banks 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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