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Dollar shaky on Fed pivot expectations

Home >  Daily Market Digest >  Dollar shaky on Fed pivot expectations

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Written by:
Myrsini Giannouli

17 November 2023
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Important calendar events

  • Retail Sales
  • EUR: Current Account, Final CPI, and Core CPI
  • USD: Building Permits, Housing Starts

USD

The dollar was shaky on Thursday, with the dollar index trading at the 104.4 level. US treasury yields remained steady on Thursday, with the US 10-year bond yielding approximately 4.45%. 

On the data front, US jobless claims on Thursday exceeded expectations, reinforcing the notion that the Fed is done raising interest rates. Unemployment claims rose to 231K for the week ending on November 11th against expectations of a 221K print. US retail sales rose by 0.1% in October exceeding expectations of a 0.1% drop. In addition, September’s print was revised higher from 0.7% to 0.8%.

The Fed’s hawkish stance over the past year has been paying off and US price pressures are cooling. Inflation in the US eased more than expected in October, driving down rate hike expectations and putting pressure on the dollar. US PPI data released on Wednesday confirmed that price pressures in the US are easing. Monthly PPI shrank by a whopping 0.5% in October, falling below expectations of a 0.1% growth. Core PPI, which excludes food and energy, remained stable, against expectations of a 0.2% growth.

Headline inflation rose by 3.2% year-on-year in October from a 3.7% reading in September and against expectations of a 3.3% print. Monthly CPI remained unchanged from the previous month in October, while markets were anticipating a 0.1% raise. Core CPI, which excludes food and energy, also surprised on the downside. Core CPI increased by 0.2% every month, compared to 0.3% anticipated.

At the latest Fed meeting in November, FOMC members voted to keep interest rates unchanged at a 22-year high within a target range of 5.25% to 5.50%. The Fed has made it clear that its approach from now on will be data-driven and Tuesday’s inflation data have brought the odds of a rate hike in December to zero. Markets are pricing at an end to rate hikes and are even starting to price in rate cuts. Markets are always ahead of events and are already pricing at an end to the Fed’s tightening policy. 

Market expectations of rate cuts have been driving the US dollar and treasury yields down. The Fed, however, has been relying on high treasury yields to complement its tightening policy. Plummeting treasury yields may derail the Fed's plans to end rate hikes or force the Fed to keep interest rates at high levels for longer.

The Fed has likely become alarmed by the recent plunge in treasury yields. Fed Chair Jerome Powell delivered a hawkish speech last week, boosting the dollar and treasury yields. Powell warned that policymakers are not confident that they have achieved a sufficiently restrictive stance to return inflation to the Fed’s 2.0% target. Powell also stressed that a sustainable drop in inflation is not guaranteed and hinted that stronger economic growth could warrant higher rates.

The US economy seems to be recovering, boosting the dollar. Advance GDP data for the third quarter of 2023 showed that the US economy expanded by 4.9%, against expectations of 4.5% growth and far surpassing the 2.1% growth of Q2. Advance GDP price index for the 3rd quarter of the year reached 3.5%, exceeding expectations of a 2.7% print. 

Core PCE Price Index, which is the Fed’s preferred inflation gauge, rose by 0.3% in September, in line with expectations. Core PCE Price Index dropped to 3.7% year-on-year in September from a 3.8% print the previous month. Inflationary pressures in the US are easing, reinforcing the notion that the Federal Reserve will not have to raise interest rates further. US headline inflation in September, however, remained at August's levels of 3.7% year-on-year, while market analysts were expecting a drop to 3.6%. 

TRADE USD PAIRS

EUR 

EUR/USD traded sideways on Thursday, oscillating around the 1.085 level. If the EUR/USD pair declines, it may find support at 1.065, while resistance may be encountered near 1.094. 

The economic outlook of the Eurozone appears to be deteriorating, putting pressure on the Euro. Flash GDP data for the Euro area on Tuesday showed that the Eurozone economy contracted by 0.1% in the third quarter of the year, which was in line with expectations. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. The EU economy is struggling and cannot withstand much further tightening. 

The ECB decided to keep interest rates unchanged at 4.50% in October. Markets anticipate that the ECB has hit its rate ceiling, putting pressure on the Euro. The ECB is tasked with assessing the risk to the fragile Eurozone economy against high inflation rates. 

ECB President Christine Lagarde has hinted at an end to rate hikes. Lagarde highlighted the risks to the Eurozone economy stressing that the economy is likely to remain weak for the remainder of the year. Lagarde also stated that it is too early to talk about rate cuts and warned that interest rates will remain at sufficiently restrictive levels for as long as necessary.

Headline inflation in the Eurozone fell to its lowest level in two years in October, mainly due to a drop in energy prices. Flash CPI cooled to 2.9% year-on-year in October from 4.3% in September against expectations of a 3.1% print. Core CPI Flash Estimate, which excludes food and energy, was in line with expectations. Core CPI eased to 4.2% year-on-year in October from 4.5% in September. The ECB’s efforts to curb inflation rates are paying off, even at the cost of decreased economic growth.

Final CPI data are due on Friday for the Eurozone and will provide information on the direction of EU inflation. 

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

GBP/USD traded sideways on Thursday around the 1.241 level. If the GBP/USD rate goes up, it may encounter resistance near 1.255, while support may be found near 1.218. 

The Sterling eased on Wednesday after CPI data showed that British inflation cooled more than forecast in October, reinforcing expectations that the Bank of England has ended its hiking cycle and will be cutting interest rates by the middle of next year. Headline inflation in the UK rose by 4.6% year-on-year in October, registering a dramatic drop from September’s 6.7% increase. Annual Core CPI, which excludes food and energy, grew by 5.7% in October versus 6.1% in September and 5.8% forecast.

Claimant Count Change, which represents the change in the price businesses pay for labor, increased by 17.8K in the three months to September compared to the same period a year earlier. This is a leading indicator of consumer inflation, and the sharp rise shows increasing inflationary pressures. Average Earnings Index data released on Tuesday showed UK workers’ wages grew by 7.9% in the three months to September, which was slightly lower than the previous record pace of 8.2%, but surpassed expectations of 7.4%. Rightmove HPI data released on Monday showed that UK housing prices have fallen at their quickest pace in five years in November, pushed down by economic tightening. 

Odds that the BOE has reached its rate ceiling are putting pressure on the Sterling. Markets are pricing in more than a 50% chance of rates being unchanged until June 2024. On the other hand, interest rates are expected to remain at their current 15-year high for a long time, with markets predicting a rate cut in August next year.

The BOE maintained its official rate at 5.25% at its latest meeting, which was in line with expectations. The BOE has likely reached its rate ceiling but will keep interest rates on hold for a long time to bring inflation down. 

BOE Governor Andrew Bailey has stated that the central bank will be watching closely to see if further rate hikes are needed. Bailey has also emphasized that the BOE will be holding interest rates in restrictive territory long enough to see inflation down to the bank’s 2% target.

Recent fundamentals have shown that the British economy remains fragile, reinforcing that the BOE has reached its peak interest rates. Prolonged tightening has taken its toll on the labor market and other vital economic sectors.

UK GDP data revealed that the British economy remained stagnant during the third quarter of 2023. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter. Economic growth is slowing down in the UK and the country is on the brink of recession.

A combination of a struggling economy and high inflation is making the BOE’s task more difficult. Further tightening is needed to bring inflation down at the risk of tipping the British economy into recession. 

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen rallied on Thursday and USD/JPY dropped to the 150.2 level. The Fed’s hawkish policy seems to be gradually coming to an end, relieving some of the pressure on the Yen, which has been weakened by the BOJ’s dovish policy.

 If the USD/JPY pair declines, it may find support near 148.8. If the pair climbs, it may find resistance at 152.

Preliminary GDP data on Wednesday showed that Japan's economy contracted in the third quarter of the year. The world's third-largest economy contracted by 0.5% in the third quarter against estimates of a 0.1% contraction. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking and is on the brink of recession. Preliminary GDP Price Index showed a 5.1% annual expansion in Q2, versus 3.5% the previous quarter. This is a measure of inflation, which shows that inflationary pressures are rising in Japan, increasing the odds of a hawkish shift in the BOJ’s policy. 

The BOJ has so far maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have raised interest rates to high levels. Japanese authorities have been repeatedly warning speculators against excessive short selling of the Yen and have stepped in several times in the past year to provide support for the Yen. 

The BOJ maintained its short-term interest rate target steady at -0.10% and that for the 10-year government bond yield around 0% set under its yield curve control, but redefined the 1.0% limit as a less restrictive ceiling rather than a rigid cap. Even though the BOJ tweaked its yield curve control policy slightly, markets were expecting a bigger shift in policy, and the Yen plummeted after the interest rate announcement. 

National Core CPI dropped to 2.8% in September from 3.3% in August. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. 

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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