Important calendar events
The dollar soared on Wednesday, propelled upwards by positive US economic activity data and the dollar index climbed above 104. US Treasury yields also moved upwards on renewed Fed rate hike expectations, with the US 10-year bond yielding over 3.8%.
US Retail Sales data on Wednesday exceeded expectations, boosting the dollar. Retail sales rose by 3.0% in January versus the 1.9% predicted. Core Retail Sales in January, which exclude automobiles, rose by 2.3%, against projections of a 0.9% growth. Empire State Manufacturing Index for February also beat expectations to the upside. The index printed -5.8, which while remaining negative, is more optimistic than the -18.2 print expected and considerably higher than the previous month’s reading of -32.9.
CPI data on Tuesday showed that price pressures in the US remain high and are not easing at the pace anticipated. US headline inflation in January dropped to 6.4% year-on-year versus the 6.2% expected. This represents a marginal cooling from December’s 6.5% print. Core CPI, which excludes food and energy, was at 5.6% against predictions of a 5.5% print.
Cooling price pressures in the past few months gave the US Federal Reserve some leeway towards scaling back its interest rate increases, putting pressure on the dollar. The Federal Reserve raised interest rates by only 25 basis points at its February meeting, bringing the benchmark interest rate to a target range of 4.50% to 4.75%.
January’s CPI print illustrates the danger of inflation becoming entrenched, which may force the Fed to rethink its recent dovish pivot. Rate hikes have become less aggressive and may continue at their current pace, but the Fed might raise interest rates for longer than previously expected. This means that there are likely still a couple of rate hikes up ahead, which may provide support for the dollar. Current market odds lean towards further tightening in the upcoming Fed meetings and an increase in interest rates up to 5.25%.
Fedspeak over the past week has been hawkish, emphasizing that further rate rises should be expected and that interest rates will need to remain high for a long period. On Tuesday, Fed’s Williams emphasized that rates still have higher to go and they will have to be kept high for some time. Fed's Bowman stated on Monday that the UC central bank aims to raise interest rates to bring inflation down below 2%.
Fed Chair Jerome Powell has stated that the disinflation process has begun but warned that it still has a long way to go. The Fed’s stance appears to be cautiously optimistic, reinforcing the notion that the Fed’s decisions will be based strongly on disinflation rates and the state of the US economy.
The US economy is expanding at a higher rate than anticipated, as US GDP for Q4 of 2022 grew by 2.9% against expectations of a 2.6% growth. The US is likely headed for an economic ‘soft landing’ and recession concerns ease.
This week, US inflation data are expected to have a significant impact on dollar prices. After Tuesday’s CPI data, Producer price (PPI) data on Thursday will help paint a clearer picture of US inflation and will also likely cause volatility in dollar price.
The Euro dipped on Wednesday, weighed down by pessimistic EU economic data. EUR/USD however was mostly driven by the dollar’s movement and tumbled as the dollar gained strength, dropping to 1.066. If the currency pair goes up, it may encounter resistance near 1.080. If the EUR/USD pair declines, it may find support at 1.065.
EU Industrial Production data for December on Wednesday fell short of expectations, declining by 1.1%, against a 0.8% decrease anticipated. Trade balance also printed lower than expected, decreasing by -18.1B in December versus the 16.0B projected.
Flash Employment Change data on Tuesday showed that Eurozone employment grew by 0.4% in Q4 of the previous year, beating forecasts of a 0.1% growth. Flash EU GDP data on Tuesday for the final quarter of 2022 fell in line with expectations. The eurozone economy expanded by 0.1%, against the growth of 0.3% in Q3 of 2022.
The European Commission released EU Economic Forecasts for the next two years on Monday. The EU economic outlook appears to be improving, with an upgraded growth forecast for 2023 and downgraded inflation expectations. The EC’s report was more optimistic than expected, concluding that the EU area would narrowly avoid entering a recession. The EC lifted their growth outlook for 2023 to 0.9%, indicating that economic recovery in the EU is starting and the economy is slowly expanding. Inflation expectations were also downgraded, with headline inflation now expected to fall to 5.6% in 2023.
ECB rhetoric following the release of the report was also optimistic, with members Centeno and de Guindos highlighting the importance of declining EU inflation. ECB members also emphasized that rate hikes beyond March will be data-dependent. The conclusions of the EC report were ambiguous for the Euro. On one hand, improving economic conditions support the Euro, but on the other, cooling price pressures may induce the ECB to pause rate hikes after March.
The ECB raised interest rates by another 50 bp at its February meeting, bringing its main refinancing rate to 3.0%. ECB President Christine Lagarde has emphasized that the central bank aims to bring inflation down to its 2% target. Lagarde confirmed that another 50-bp rate hike would follow at the next monetary policy meeting in March, after which the ECB would re-evaluate its policy. Market odds are currently favoring an increase of the ECB refinancing rate to 4.0% by June.
EU inflation rates are decreasing, but they are still far from the ECB’s 2% goal. Final EU headline inflation dropped to 8.5% year-on-year in January from a 9.2% print in December, indicating that Eurozone inflation is cooling. The continued drop in inflation signals that the ECB’s efforts to tame inflation are bearing fruit. Price pressures in the Eurozone remain high though, and interest rates need to rise to combat inflation.
Several economic activity data are scheduled to be released on Thursday for the Eurozone. These include ECB Economic Bulletin, Italian Trade Balance, Spanish 10-y Bond Auction, and German 10-y Bond Auction, and may cause some volatility in Euro price.
The Sterling plummeted on Wednesday after CPI data showed that UK headline inflation cooled at a higher pace than anticipated in January and GBP/USD dropped to 1.198. If the GBP/USD rate goes up, it may encounter resistance at 1.227, while support may be found near 1.196.
British CPI fell to 10.1% year-on-year in January from 10.5% in December. Core CPI, which excludes food and energy, dropped to 5.8% on an annual basis from 6.3% in December.
The BOE raised interest rates by another 50 bp at its February meeting, bringing the official bank rate to 4.0%. The BOE Monetary Policy Report issued after the meeting was more dovish than expected, pointing to a possible pause in rate hikes. After Wednesday’s optimistic inflation print, market odds lean towards a 25-bp rate hike at the BOE's next monetary policy meeting in March.
BOE Monetary Policy Report Hearings last week indicated that BOE officials are divided over the central bank’s future monetary policy. The dichotomy between MPC members does not bode well for the British economic outlook, as there is a high risk that inflation will become entrenched.
British labor data on Tuesday showed that unemployment rates remain steady. Unemployment rates remain low, but businesses cite economic pressures for not hiring more workers. Wages in the UK increased by 5.9% in October through December over the same month in the previous year, against estimates of a 6.4% rise. Wage growth in the UK remains slow, lagging behind inflation.
Recent GDP data showed that the British economy is slowing down. The British economy contracted by 0.5% in December, which was more pessimistic than the 0.3% expected. Preliminary GDP for the final quarter of 2022 showed stagnation, while GDP for 2022 came in at 4.1%. The IMF 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.
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.
The Yen extended losses on Wednesday, pushed down by expectations of the continued dovish policy after the announcement of the Japanese Government’s nomination for the next BOJ Governor on Tuesday. USD/JPY soared as the dollar gained strength, climbing above 134.2. If the USD/JPY pair declines, it may find support near 129.8. If the pair climbs, it may find resistance at 134.8.
Incumbent BOJ Governor Haruhiko Kuroda’s term in office expires in April. BOJ Governor Kuroda is a staunch supporter of an ultra-loose monetary policy. Japanese Prime Minister Fumio Kishida nominated former BOJ member Kazuo Ueda for the post of BOJ governor on Tuesday. Ueda is an academic economist and is also a firm supporter of the central bank’s ultra-loose monetary policy, warning repeatedly against prematurely unwinding Japan’s ultra-loose stance. A change in leadership with Ueda at the helm would probably make little difference in BOJ policy. Ueda will likely not be in a hurry to unwind the BOJ’s ultra-easy policy. Market reaction reflected this eventuality, and the Yen has been declining over the past few days.
Japanese policymakers maintained ultra-low interest rates at the BOJ’s January meeting, keeping the central bank’s refinancing rate at -0.10%.
Preliminary GDP data for the final quarter of 2022 on Tuesday showed minimal economic expansion by 0.2%, falling short of expectations of 0.5% growth. The preliminary GDP Price Index on an annual basis printed 1.1% for 2022, mainly due to the high costs of imported energy. Japan’s economic outlook is poor, raising recession concerns for the world’s third-biggest economy.
BOJ Core CPI rose to 3.1% year-on-year, exceeding expectations of a 2.9% print. Inflation in Japan has gone above the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households. National Core CPI for December was at 4.0%, rising above November’s 3.7% print. In addition, wages in Japan increased for the first time in nine months by 4.8% year-on-year in December. Increased price pressures and wages raise concerns of a wage-price spiral and may force the BOJ to pivot towards a more hawkish policy.
Core Machinery Orders and Trade Balance data for Japan on Thursday may affect the Yen, although USD/JPY will probably be driven primarily by the dollar’s movement this week.
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