Important calendar events
The dollar tumbled on Monday, on reduced inflation expectations. The dollar index plummeted from 103.8 in early trading to 103.0 by the end of the day.
US Treasury yields also followed a declining trajectory on Monday, with the US 10-year bond yield dropping from 3.61% to 3.52% on diminished Fed rate hike expectations.
Reduced inflation expectations put pressure on the dollar on Monday. US CPI data are scheduled to be released on the 12th and are this week’s most highly anticipated fundamentals. Market participants are anxiously awaiting the US inflation print, which may determine the dollar’s trajectory.
US inflation seems to be cooling, as US headline inflation dropped to 7.1% year-on-year in November. Reduced price pressures may give the US Federal Reserve some leeway towards scaling back its interest rate increases in the following year. US economic outlook and inflation will likely determine the pace of rate hikes in 2023. Many analysts believe that the Fed will ease its rate hikes in 2023, but will continue raising interest rates at a slower pace until the benchmark interest rate reaches at least 5.0%. This means that there are likely still a couple of rate hikes up ahead, which may provide support for the dollar into 2023.
Fed rate hike expectations have been the main factor driving the US dollar and treasury yields over the past few months. At the latest monetary policy meeting in December, FOMC members voted to raise interest rates by 50 basis points, bringing the Fed’s benchmark interest rate to a target range of 4.25% to 4.50%.
The interest of market participants is now mostly focused on what lies ahead for the Fed. Market uncertainty regarding the future direction of the Federal Reserve is causing fluctuations in dollar prices.
Global recession concerns remain high, boosting the dollar. US GDP data revealed that GDP rose by 3.2% for the third quarter of 2022. The US economy is still expanding, but at a slower pace than anticipated and recession looms.
Federal Reserve chair Jerome Powell is due to deliver a speech on Tuesday, which will likely draw traders’ attention and may cause volatility in dollar prices.
The Euro extended gains on Monday, boosted by the dollar’s decline and EUR/USD surged to 1.076. If the currency pair goes up, it may encounter resistance at 1.078. If the EUR/USD pair declines, it may find support at 1.048.
Economic activity indicators released for the Eurozone on Tuesday were overall mixed. French Trade Balance dropped to -13.8B in November from -11.6B in October. The Sentix Investor Confidence in January rose to -17.5 from a print of -21.0 in December. Even though a negative value denotes pessimism, the latest print is more optimistic, indicating improving economic conditions in the Eurozone.
Increased price pressures combined with a weak economic outlook have brought stagflation in the Eurozone, a toxic mix of high inflation and stale economic growth. EU headline inflation dropped to 9.2% year-on-year in December from a 10.1% print in November indicating that Eurozone inflation is cooling. This is the first drastic drop in inflation that 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 significantly to combat entrenched inflation.
EU inflation rates are still far from the ECB’s 2% goal and are forcing the central bank to hike rates aggressively. In its latest monetary policy meeting in December, the ECB raised interest rates by 50 bp, bringing its benchmark interest rate to 2.50%.
The question however is, whether economic conditions in the Eurozone will allow the ECB to continue raising interest rates at a fast pace. The ECB has updated its economic growth forecast by 3.4% in 2022, 0.5% in 2023, 1.9% in 2024, and 1.8% in 2025. These are lower than previous estimates, indicating that Eurozone economic outlook is poor and that the ECB might be forced to raise interest rates in a recessionary backdrop.
Only minor fundamentals are due on Tuesday for the EU, which are not likely to cause volatility in Euro price. ECB member rhetoric will likely affect the Euro this week and the dollar’s trajectory.
The Sterling continued its upwards trajectory on Monday, benefitting from the dollar’s decline and GBP/USD climbed to 1.220. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.184.
On Monday, BoE Chief Economist Huw Pill stressed the risks of persistent inflationary pressures from labor shortages in the UK. He added, however, that the BOE has already made significant progress towards the normalization of monetary policy, hinting at a slower pace of rate hikes up ahead.
The British economy is constrained and the country is already in the grip of recession. The final GDP print for the third quarter of 2022 was -0.3%, which fell below expectations, indicating that the economy in the UK is shrinking. The BOE recently revised its economic growth projections, with GDP expected to drop by 0.1% in Q4 2022. The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down.
At the same time, surging inflation has forced the BOE to adopt a more hawkish fiscal policy, bringing its interest rate to 3.50% in December, its highest rate in 14 years. After a year of fiscal tightening, UK headline inflation finally dropped to 10.7% in November, alleviating some of the pressure on the BOE to raise interest rates. In the latest monetary policy meeting in December, BOE members voted to hike rates by 50 bps. With inflation remaining above 10%, this was perceived by many analysts as the start of a pivot toward a more dovish fiscal policy, putting pressure on the Sterling.
The BOE gave uncertain forward guidance at its latest policy meeting in December, leaving the door open for further rate hikes, but signaling that interest rate increases might pause within the first quarter of 2023. The UK’s grim economic outlook may limit policymakers’ ability to increase interest rates sufficiently in 2023 to rein in inflation.
Minor economic activity indicators are scheduled to be released on Tuesday for the UK. These include BRC Retail Sales Monitor, PPI Input, and Output and may cause some volatility in the Sterling price.
The Yen traded sideways against the dollar on Monday, with the USD/JPY oscillating around the 131.9 level. If the USD/JPY pair declines, it may find support near 129.5. If the pair climbs, it may find resistance at 138.2.
Monday was a Bank Holiday in Japan and the Yen traded with low volatility, directed mainly by the dollar’s trajectory. Increasing oil prices on Monday put pressure on the Yen. Japan is a net energy importer and increasing oil prices affect the country’s economy.
The BOJ caused a stir in markets in December by finally yielding to increased price pressures and tilting its monetary policy. In the latest monetary policy meeting, Japanese policymakers maintained the central bank’s refinancing rate at -0.10%. The BOJ however, changed its yield control target for its 10-year government bond to between plus or minus 0.50%, from a previous 0.25%. The BOJ had set a target range around zero for government bond yields for years, and this adjustment may be the signal of a shift towards a more hawkish policy. Long-term, this move may allow interest rates to rise, cutting off some of its monetary stimuli.
Meanwhile, BOJ Governor Haruhiko Kuroda has been reaffirming the central bank’s commitment to its ultra-easy policy. Kuroda however, is due to retire in April and his successor may decide to unwind the BOJ’s ultra-easy policy. A pivot in Japan’s monetary policy within 2023, would boost the Yen considerably.
The final GDP Price Index for the third quarter of 2022 showed economic contraction by 0.3% on an annual basis and the final quarterly GDP for Q3 of 2022 printed at -0.2%. The Japanese economy shrank in the third quarter of 2022, mainly due to the high imported energy costs. Japan’s economic outlook is poor, raising recession concerns for the world’s third-biggest economy.
Price pressures continue to rise in Japan, as BOJ CPI rose to 2.9% on an annual basis, mainly due to the high cost of imported energy. Inflation in Japan has gone above the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households.
On the data front, Household Spending and Tokyo Core CPI are scheduled to be released on Tuesday. The CPI indicator may cause some volatility in the Yen price, as inflation in Japan may influence the BOJ’s future policy.
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