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The dollar gained strength on Tuesday, with the dollar index rising above 103.5. US Treasury yields weakened, however, on reduced rate hike expectations, with the US 10-year bond yield rising to 3.7%.
Upbeat economic activity data on Tuesday provided support for the dollar. Flash Services PMI data rose to 55.1 in May, exceeding expectations of a 52.6 print and rising above April’s 53.6 print. A value above 50 indicates that the services sector is expanding at an increasing pace. The Manufacturing sector, on the other hand, is starting to shrink. US Flash Manufacturing PMI dropped into contractionary territory with a 48.5 print in May from 50.2 in April, versus the 50.0 expected.
The ongoing debate around the US debt ceiling is causing economic uncertainty and may affect dollar prices. The US dollar and Treasury yields were buoyed on Tuesday by debt default fears. US Treasury Secretary Janet Yellen has warned that the office would not meet all US government obligations by June 1. Yellen updated her prognosis on the US debt earlier this week, stating that it is ‘highly likely’ that the debt ceiling will be pierced in early June, upgrading her warning from ‘likely’ a couple of weeks ago.
House Speaker McCarthy and President Biden started talks on the debt ceiling last week, which were considered to be productive. US President Biden stated that he is confident that he, and House Speaker McCarthy, will agree on the budget. The two leaders have yet to reach an agreement on the US debt ceiling, but negotiations continue as the clock runs down.
US Federal Reserve Chair Jerome Powell caused a stir in markets last week, however, as his statements at a Fed conference in Washington indicated that the US Central Bank may pivot towards a more dovish direction. Powell indicated on Friday that, after 10 straight rate hikes, the Fed may be considering a pause in rate hikes in June. Powell remarked that “the risks of doing too much versus doing too little are becoming more balanced.” This was a marked shift from his stance earlier in the year, hinting at a pivot to a more dovish fiscal policy.
US Headline inflation dropped to 4.9% year-on-year in April, decelerating from a 5.0% print in March. US Inflation cooled more than expected in April, as markets were anticipating a 5.0% print. Core CPI, however, which excludes food and energy, proved to be persistent, remaining at 5.5% year-on-year. Slowing inflation increases the chances that the Federal Reserve could pause its interest rate hikes.
The Federal Reserve raised interest rates by 25 basis points at its latest monetary policy meeting, bringing the benchmark interest rate to a 16-year high target range of 5.00% to 5.25%.
Markets anticipate a pause in rate hikes after May’s interest raise. The US Central Bank has signaled that its hawkish policy is coming to an end, as prolonged tightening is putting the economy at risk and the recent turmoil in the banking sector has increased recession concerns. Many analysts predict that there is a high probability of rate cuts starting in November, depending on economic conditions and inflationary pressures.
Advance GDP data for the first quarter of the year showed that the US economy expanded by 1.1% against expectations of 2% and a 2.6% growth in Q4 of 2022. Advance GDP Price Index on the other hand rose by 4.0% in Q1 of 2023, versus 3.7% expected. This index is a measure of inflation and indicates that price pressures remain high.
The minutes of the latest Fed meeting are scheduled to be released on Wednesday and may provide some insight into the Fed’s future policy direction. Treasury Secretary Yellen is also due to deliver a speech on Wednesday, which may affect the dollar in case the issue of the US debt ceiling is mentioned. Core PCE Price Index on the 26th is one of the most highly anticipated fundamentals this week, as it is the Fed’s preferred inflation gauge.
The Euro weakened against the dollar on Tuesday and EUR/USD dropped to the 1.077 level. If the currency pair goes up, it may encounter resistance near 1.090. If the EUR/USD pair declines, it may find support at 1.075.
Economic activity data released on Tuesday for the Eurozone were disappointing, putting pressure on the Euro. Flash Eurozone Services PMI Activity dropped to 55.9 in May from 56.2 in April. May’s print, however, exceeded the expected 55.5 value and remained firmly above the threshold of 50 which denotes industry expansion. The Manufacturing sector, however, continues to shrink, at an increasing pace. Flash Eurozone Manufacturing PMI dropped to 44.6 in May from 45.8 in April, registering a 36-month low.
The ECB raised interest rates by 25 bp at its latest monetary policy meeting last week, bringing its main refinancing rate to 3.75%. The ECB had raised interest rates by 50 bp in previous meetings and is slowing down the pace of rate hikes.
The ECB has left the door open for further rate hikes as inflationary pressures in the EU remain high. The ECB, however, is expected to reassess its policy direction ahead of its next meeting in June. EU policymakers must take a lot of variables into account, including the effect of economic tightening on the now fragile banking sector.
ECB President Christine Lagarde has stated that the ECB is approaching a key juncture and that further action is necessary to bring inflation down to the bank’s 2% goal. Lagarde’s comments point to further rate hikes up ahead, while the US Fed has signaled a pause in rate hikes.
Price pressures in the Eurozone remain high. Headline inflation rose to 7.0% year-on-year in April from 6.9% in March, in line with expectations. Core CPI, which excludes food and energy, dropped slightly to 5.6% on an annual basis in April from 5.7% in March. Eurozone inflation is not showing signs of cooling despite the ECB’s aggressive tightening.
GDP Flash data for the first quarter of the year showed that the Eurozone economy expanded by 0.1%, registering a small improvement against the 0 print for the final quarter of 2022.
Important indicators of economic activity and health are due on Wednesday for Germany, which is the Eurozone’s leading economy, and they may affect the Euro.
The Sterling lost strength on Tuesday and the GBP/USD pair dropped to the 1.241 level. If the GBP/USD rate goes up, it may encounter resistance near 1.254, while support may be found near 1.234.
UK business activity data came in below expectations on Tuesday, weighing the Sterling down. Flash Services PMI data dropped to 55.1 in May from 55.9 in April, against expectations of a 55.5 print, showing that growth slowed more than expected in the Services sector. The services index, however, remained firmly above the 50 threshold that denotes industry expansion. The British Manufacturing sector continued to shrink, however. Flash Manufacturing PMI data dropped to 46.9 in May, from 47.8 in April, versus 47.9 predicted.
BOE governor Andrew Bailey has stated that Britain’s labor market is showing signs of reduced inflationary pressures. Bailey, however, stressed that the easing in labor market tightness is happening at a slower pace than anticipated. Signs of cooling inflationary pressures may encourage the BOE to halt its hawkish monetary policy.
The BOE raised interest rates by 25 basis points at its latest meeting in May, bringing the bank rate to 4.5%. Market odds are in favor of more BOE rate hikes up ahead and many analysts predict no rate cuts at all within the year. After Bailey’s speech, however, the odds of another rate hike at June’s policy meeting went down.
The BOE has been following an aggressively hawkish monetary policy, aiming to bring inflation down. Inflation in the UK is still rampant, however, after more than a year of raising interest rates. British headline inflation remained above the 10% level in March, dropping to 10.1% year-on-year from 10.5% in February. Inflation in the UK has become entrenched, forcing the BOE to continue its policy of economic tightening against a weak economic backdrop.
The UK economy registered stagnation in March according to recent GDP data. Monthly GDP dropped to zero, falling below expectations of 0.1% expansion. In addition, the IMF has downgraded the UK’s growth forecast, predicting that the British economy will contract by 0.6% this year, which is also consistent with BOE forecasts. April’s GDP print will be released on Friday, a day after the BOE policy meeting.
The UK’s grim economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The British economy is struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down.
Important indicators of inflation are scheduled to be released on Wednesday, especially the highly-anticipated CPI data. BOE Governor Andrew Bailey is also due to deliver a speech on Wednesday, which may affect the Sterling in light of his dovish comments last week.
The Yen extended losses on Tuesday and USD/JPY rose to its highest level since November, touching 138.9 before sliding to 138.5 at the end of the day. If the USD/JPY pair declines, it may find support near 133.7. If the pair climbs, it may find resistance at 139.
The safe-haven Yen has benefitted in the past few weeks from fears of a US debt default. The start of negotiations between House Speaker McCarthy and President Biden on the US debt ceiling, however, put pressure on the Yen last week. Talks between the two officials were resumed on Monday. The two leaders have yet to reach an agreement on the US debt ceiling, but negotiations continue, raising optimism that a deal will be struck before the clock runs down on the US economy. Increased risk-on sentiment drove the Yen down this week.
BOJ Core CPI rose to 3.0% year-on-year in April from 2.9% in March, according to data released on Tuesday. April’s print exceeded expectations of a 2.8% growth, indicating that price pressures in Japan continue to rise. Tokyo Core CPI for April was also hotter than expected, at 3.5% on an annual basis, against expectations of a 3.2% print. Inflation in Japan remains steadily above the BOJ’s 2% target, putting pressure on businesses and households. Increased price pressures and wages, raise concerns of a wage-price spiral and may force the BOJ to pivot towards a more hawkish policy.
Preliminary GDP data for the first quarter of the year released last week were optimistic, providing support for the Yen. The Japanese economy expanded by 0.4% in Q1 of 2023, after reaching stagnation during the last quarter of 2022. The GDP data exceeded expectations of a 0.2% growth in the first quarter of the year, alleviating recession concerns for Japan. The final GDP Price Index printed showed a 2.0% annual expansion, versus 1.2% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.
The BOJ decided to continue its dovish monetary policy at the bank’s latest meeting in April. This was the first meeting with the newly-appointed BOJ Governor Kazuo Ueda at the helm. Japanese policymakers maintained ultra-low interest rates at the BOJ policy meeting, keeping the central bank’s refinancing rate at -0.10%.
The BOJ modified its forward guidance slightly at its latest meeting by removing a pledge to keep interest rates at current or lower levels. In addition, the BOJ announced a review of the impact of its easing policies with a planned time frame of around one to one-and-a-half years. This signals a policy change down the road, although it is clear that the BOJ does not have any immediate plans to pivot to a more hawkish policy.
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Myrsini Giannouli
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