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Dollar volatile ahead of US inflation data

Home >  Daily Market Digest >  Dollar volatile ahead of US inflation data

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Written by:
Myrsini Giannouli

12 October 2022
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Important calendar events

  • GBP: GDP, Construction Output, Goods Trade Balance, Index of Services, Industrial Production, Manufacturing Production
  • EUR: Industrial Production, ECB President Lagarde Speech
  • USD: Monthly PPI and Core PPI, FOMC Meeting Minutes

USD

The dollar experienced high volatility on Tuesday. The USD started strong in early trading on Tuesday, collapsed later in the day, and finally bounced back. The dollar index fell to 112.4 and then rallied climbing back to 113.3. US Treasury yields gained strength, with the US 10-year bond yielding almost 4.0%.  

Global recession concerns are causing high market volatility ahead of the US inflation data later in the week. Sharp rate hikes and continuous fiscal tightening run the risk of tipping some of the world’s leading economies into recession. World Bank President David Malpass and International Monetary Fund Managing Director Kristalina Georgieva warned earlier this week of a growing risk of global recession while stressing the need to bring inflation under control.

Hawkish Fed rhetoric in the past few weeks has been increasing the odds of a steep rate hike at the Fed’s next monetary policy meeting. FOMC member Loretta Mester stated on Tuesday that US inflation is unacceptably high and persistent and that the Fed’s goal for next year is to bring it down to 3.5%. On Monday, FOMC member Charles Evans stated there was a strong consensus at the Fed to raise its interest rate to around 4.5% by March and hold it there until inflation was under control. Fed Reserve Vice Chair Lael Brainard also emphasized the central bank’s priority to fight the highest inflation in 40 years and stressed the risks of easing fiscal tightening prematurely.

The US Federal Reserve recently voted to raise its interest rate by 75 basis points to curb soaring US inflation rates. The US Central Bank has increased interest rates by a total of 300 basis points this year, bringing its benchmark interest rate from 2.50% to 3.25%. 

So far, US inflation does not show signs of cooling at the expected rate, despite the Fed’s efforts. Core PCE Price Index, the Fed’s favorite inflation gauge, increased 0.6% month-on-month in August, compared to a forecast of 0.5%, with the annual reading climbing to 4.9%. Inflation in the US remains high, putting pressure on the Fed to maintain its hawkish stance. This week market participants await the release of the latest US inflation data on Wednesday and Thursday.

Monthly PPI and Core PPI data are scheduled to be released on Wednesday, which is a strong inflation indicator and may affect the dollar. The Minutes of the latest Fed meeting are also due on Wednesday.

TRADE USD PAIRS

EUR 

The Euro traded sideways against the dollar on Tuesday. The EUR/USD pair fluctuated around the 0.970 level, experiencing some volatility during the day as the dollar prices seesawed. If the EUR/USD pair declines, it may find support near the 0.961 level and further down at the 0.845 level representing the 2002 low. If the currency pair goes up, it may encounter resistance at 1.005 and further up at 1.019. 

Escalating Russian hostilities against Ukraine at the beginning of the week have triggered a risk-aversion sentiment. A series of Russian missile attacks against Ukrainian cities bolstered the safe-haven dollar. U.S. President Joe Biden spoke with Ukrainian President Volodymyr Zelensky on Monday condemning the latest attacks, while G-7 leaders vowed to help Ukraine for ‘as long as it takes. 

Europe is facing an energy crisis, driven by the EU’s dependency on Russian energy. High energy costs in the Eurozone are driving the Euro down, while inflationary pressures mount. The ongoing geopolitical crisis is putting pressure on Eurozone economies resulting in pressure on the Euro. 

Eurozone inflation is on the rise, intensifying the EU’s economic crisis. Eurozone inflation reached double digits in September, climbing to 10% on an annual basis, compared to 9.1% in August, beating estimates of 9.7%. Inflation in the EU is expected to rise even further in the following months driven by the high cost of energy in the Eurozone. Increased price pressures are forcing the ECB to take swift action to tackle inflation. 

Soaring EU inflation rates and hawkish ECB rhetoric increase the odds of a 75-bp rate hike at the Bank’s next meeting in October. The Euro has been pushed down by the gap in interest rates with the US. The US Federal Reserve recently voted to raise its interest rate by 75 basis points, bringing its benchmark interest rate to 3.25%. In its latest monetary policy meeting, the ECB raised its benchmark interest rate by 75 basis points as well, but its interest rate is still only 0.75%, putting pressure on the Euro. 

ECB President Christine Lagarde is due to deliver a speech on Wednesday, which may cause some volatility in the Euro price. 

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

The Sterling rallied early on Tuesday, supported by the dollar’s weakness but fell later in the day as the dollar rallied. The GBP/USD rose to the 1.117 level but pared its gains falling to 1.098. If the GBP/USD rate goes up, it may encounter resistance near 1.149 and higher up at 1.173, while support may be found at the new all-time low of 1.035. 

Economic activity indicators released on Tuesday for the UK were overall mixed. UK Employment data were robust, with the unemployment rate for August dropping to 3.5% compared to 3.6% the previous month. Average earnings of British workers for the past 3 months went up by 6.0%, compared to 5.9% during the same period last year. The number of claimants for unemployment in the UK however, went up to 25.5K in September from only 1.1K in August. 

The Bank of England announced on Monday that it would increase its gilt market purchase program from a daily maximum limit of GBP5 billion to GBP10 billion for the rest of the week. The BOE had recently announced its bond-buying program, aiming to stem the sell-off in the UK gilt market by buying long-dated gilts, which have been strongly affected by repricing. On Monday, the BoE increased market liquidity ahead of the end of the gilt buying program on Friday. The announcement boosted the Sterling, which had been slipping again in the past few days.

The Sterling has been declining for the past couple of weeks, as the announcement of the first ‘mini-budget’ brought the market’s distrust of the new British government, driving the pound to an all-time low. The budget included major tax cuts, which would primarily benefit the highest earners in a time of heightened economic pressure on British households.  

British Prime Minister Liz Truss defended the budget initially, and the new Government received heavy criticism for some parts of the plan. Last week, however, the British Government made a U-turn, scraping some of the most controversial parts of the mini-budget, and boosting the Sterling.

Recession concerns are also weighing the currency down. The BOE has warned that recession is expected to hit the UK in the fourth quarter of this year, and is forecasted to last for five quarters, until the end of 2024 with GDP falling to 2.1%. 

The Bank of England raised its interest rate by 50 bps in its latest meeting, bringing the total interest rate to 2.25%. The BOE continues to tighten its monetary policy to bring inflation under control, although annual inflation in August dropped to 9.9% from 10.1% in July. The BOE has adopted a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. In contrast, the Fed is ramping up efforts to combat US inflation by raising its interest rate by 75 basis points. 

Important economic indicators are scheduled to be released on Wednesday for the Sterling, such as GDP, Construction Output, Goods Trade Balance, Index of Services, Industrial Production, and Manufacturing Production. These may provide information on the British economic Outlook and may affect the currency.

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen lost ground against the dollar on Tuesday, and the USD/JPY pair continued trading above the 145 thresholds, reaching as high as 145.9. If the USD/JPY pair falls, support might be found near 143.5 and further down at 141.5. If the pair climbs, it may find further resistance higher up at the 1998 high of 147.7.

Economic activity indicators released on Tuesday for Japan were overall positive for the Japanese economy. The Economy Watchers Sentiment indicator, which gauges current economic conditions, exceeded expectations and went up to 48.4 in September compared to 45.5 in August.

Hawkish Fed rhetoric has been increasing the odds of a Fed rate hike supporting the dollar at the expense of competing assets. The USD/JPY has been trading above the 145 level for the third consecutive day. This level seems to represent a line in the sand, as the Japanese government rushed to intervene when the currency pair threatened to cross this level in September. 

The Japanese Ministry of Finance intervened last month in the Foreign Exchange market for the first time since 1998, buying Yen for dollars. It remains to be seen whether Japan will continue to defend the 145 level in the following days, although the government of Japan cannot sustain such a plan indefinitely. 

On the other hand, the BOJ is unlikely to reverse its dovish policy to aid the struggling Yen. In its latest monetary policy meeting, the BOJ maintained its ultra-easy monetary policy keeping its main refinancing rate at -0.10%. Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down. The US Federal Reserve voted to raise its interest rate by 75 basis points last week and the wide difference in interest rates is putting pressure on the Yen.

Several minor economic indicators are scheduled to be released this week for Japan, but these are not expected to have a significant impact on the Yen.

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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