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Dollar supported by increasing Fed rate hike bets

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Written by:
Myrsini Giannouli

27 April 2022
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Important calendar events

  • GBP: CBI Realized Sales
  • EUR: German GfK Consumer Climate, ECB President Lagarde Speech
  • USD: Goods Trade Balance, Monthly Preliminary Wholesale Inventories, Monthly Pending Home Sales, Crude Oil Inventories

USD

Last week, continued Russian hostilities against Ukraine and increased sanctions on Russia increased risk-aversion sentiment, providing support for the safe-haven dollar, with the dollar index rising above the 101 level. The dollar index continued rising this week going above 102 on Tuesday, close to its 2020 high.

Yields also rose across the US treasury curve last week, with the US 10-year treasury note touching 3% for the first time since 2019. This week US yields retreated a little, but remain at high levels, with the US 10-year treasury note above 2.7% on Tuesday.

Inflation remains one of the biggest problems for the US economy, with headline inflation rising to 8.5%, its highest rate since 1981. Producer Price data jumped by 11.2% from last year’s data, marking the biggest increase on record in over a decade. Soaring inflation rates in the US have increased expectations of a high rise in the Fed’s benchmark interest rate, buoying the dollar.

Over the past couple of weeks, Fed rhetoric has been one of the primary drivers of USD price, as the Fed signals a faster pace of policy tightening in the US. Markets are beginning to price in a steep rate hike of 50 base points at the Fed’s next policy meeting in May. Markets have been pricing in a total of over 225 base points of additional interest rate hikes this year, boosting the dollar.

US Federal Reserve Chair Jerome Powell’s recent statements are in favor of an aggressive rate hike. Powell stated last week that a 50 base point increase in the Fed’s benchmark interest rate is on the table for the Fed’s next policy meeting in May. 

Several economic indicators are scheduled to be released on Wednesday for the dollar, including Goods Trade Balance, Monthly Preliminary Wholesale Inventories, and Monthly Pending Home Sales. These, however, are not expected to affect the currency significantly.

TRADE USD PAIRS

EUR 

The Euro continued trading at a two-year low against the dollar on Tuesday, with the EUR/USD testing the 1.063 level support at the end of the day. The 1.063 level marks 2020 low and 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 bearish, but if the currency pair goes up, it may encounter resistance at 1.118. 

Emmanuel Macron’s triumphant victory in the French elections on Sunday provided political stability in one of the Eurozone’s leading economies. His victory had already been priced in by markets though and did not have a significant impact on the Euro.

The ECB has been pursuing a more cautious fiscal policy than other major Central Banks and does not plan to raise its benchmark interest rate before the end of its bond-buying program in the third quarter of 2022. As the Fed and the BOE have already raised their benchmark interest rates, the Euro remains at a disadvantage from the difference in interest rates.

Soaring inflation rates in the EU increase the chances of an eventual shift towards a more hawkish policy. The ECB however, is 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.

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 signs of wavering though, as rising inflationary pressures are forcing the ECB to act to drive inflation down. 

Last week, Lagarde stated that there is a strong chance of an ECB rate hike within the year but warned other ECB members against making statements before policy meetings. On Tuesday however, one of the more hawkish ECB members, Martins Kazaks, stated that the ECB could start hiking its interest rates as early as July and pointed to 2-3 rate hikes within the year. 

ECB President Christine Lagarde is due to deliver a speech on Wednesday at the Manager Magazine's Top100 women in German Business event in Hamburg. Her speech will be scanned closely by market participants for hints into the ECB's future policy direction. As the ECB monetary policy is one of the primary drivers of the Euro, Lagarde’s statements have the potential to affect the currency, especially any hints of a potential hawkish shift in the Central Bank’s policy. 

EURUSD 1hr chart

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GBP 

The sterling plummeted on Tuesday, with the GBP/USD rate falling sharply below the 1.267 support level, reaching near 1.257. 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, further support may be found near the two-year low at 1.206. 

The pound has been declining, weighed down by the heavy political climate in the UK and a sluggish British economy. British PM Boris Johnson is still dealing with the aftermath of the ‘party gate’ scandal and the resulting political uncertainty is affecting the currency. Last week, members of the British parliament voted on whether Boris Johnson should be referred to parliament’s privileges committee for an inquiry into breaches of lockdown rules. Although the voting was in the British PM’s favor, Johnson continues to receive heavy criticism over his breaches of lockdown regulations at the start of the pandemic. 

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, there are signs that its stance may soften in the coming months, weighed down by a fragile economy. In contrast, the increasingly hawkish Fed rhetoric is boosting the dollar against the pound.

Last week, BOE Governor Andrew Bailey 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. His comments were supported by economic data released last week, which showed that the British economy is sluggish and economic recovery is still a long way off. Retail sales and Flash Services PMI data last week were lower than anticipated increasing the chances that the BOE will adopt a more conservative policy to balance rising inflation against slow economic growth.

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%. UK inflation has hit a 30-year high and is expected to rise further in the coming months, with a peak rate close to 9% in Q4. Soaring inflation rates in the UK increase market expectations that the BOE will raise its benchmark interest again in the second quarter of 2022, after already lifting the Bank Rate from 0.1% to 0.75% in the past few months.

GBPUSD 1hr chart

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JPY 

The USD/JPY has been gaining strength these past few weeks, pushing past the resistance level of 2015 high at 125.8. The USD/JPY pair traded sideways on Tuesday, declining from last week’s record high of 129.4 and trading around the 127.4 level. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level. 

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.

Unemployment Rate data released on Tuesday for Japan were slightly positive, showing that the jobs sector is recovering from the effects of the pandemic. Annual BOJ Core CPI data also released on Tuesday, fell within market expectations and did not affect the currency significantly. Inflation rates in Japan remain at low levels, but this is not expected to cause a shift in the BOJ’s policy ahead of the next BOJ meeting. 

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.

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 Bank of Japan has maintained its negative interest rate from -0.10%, while other Central Banks 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.

Japan’s core CPI may climb around 2% in April, similar to other countries that are expected to see a peak in inflation rates around the same time, largely due to the effect of the increase in oil prices. Japan is a net energy importer and the current energy crisis is damaging the country’s terms of trade and overall economic health. The rising cost of oil is causing goods prices to rise in Japan, with oil imports accounting for 80% of the country’s oil consumption. 

The next BOJ policy meeting is on Thursday, April 28th. The BOJ will announce its main interest rate and will release an outlook report on Thursday, detailing the factors that shape its monetary policy. Although the BOJ is widely expected to keep its interest rate unchanged and continue its ultra-accommodating policy, the event is likely to generate some volatility for the currency. The BOJ will also release a press conference after the conclusion of the meeting, which will be followed closely by market participants for hints into the bank’s future policy. A more hawkish statement will provide the Yen with a much-needed boost, while a communication along the same dovish lines the BOJ has been following, might see the price of the Yen falling even lower.

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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