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Dollar volatile as US inflation hits 9.1%

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Written by:
Myrsini Giannouli

14 July 2022
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Important calendar events

  • JPY: Revised Industrial Production
  • GBP: BOE Credit Conditions Survey
  • USD: PPI and Core PPI, Unemployment Claims

USD

The dollar prices showed high volatility on Wednesday, with the dollar index fluctuating between 108.5 and 107.5. US Bond yields remained strong on Wednesday, with the US 10-year treasury note yielding approximately 3%.

CPI and Core CPI data released on Wednesday showed that US inflation in June hit a 40-year high of 9.1% on an annual basis. Monthly CPI data spiked to 1.3% from 1% last month, exceeding expectations. Core CPI data, which exclude food and energy, was also higher than expected, reaching 0.7% from 0.6% last month. The dollar index rose above a 20-year high of 108.5 before the release of the CPI data. Record high inflation rates for June had been already priced in by markets though, and the dollar retreated after the release of the CPI data.

The global economic outlook is poor, with a recession threatening many countries. Rampant inflation, combined with tightening monetary policy creates a toxic economic mix. Recession fears and geopolitical risks increase risk aversion sentiment, boosting the safe-haven dollar. 

Financial indicators released last week for the US created a positive economic outlook, boosting the dollar. Robust financial and employment data show that the US economy is not at imminent risk of recession, increasing the chances of a steep rate hike in July. 

In its latest policy meeting, the US Federal Reserve voted to raise its benchmark interest rate by 75 points, taking aggressive action against inflation. High US inflation rates are forcing the Fed to tighten its monetary policy. Another rate hike of 75 base points is expected for July and is already been priced in by markets, catapulting the dollar to record highs. 

PPI and Core PPI data are scheduled to be released on Thursday. Combined with Thursday’s CPI data, the PPI data are expected to paint a clear picture of the current inflation conditions in the US. These data are expected to affect dollar price, as they are key indicators of consumer inflation and may play a decisive role in determining the level of fiscal tightening that the Fed is going to decide on this month.

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EUR 

The Euro gained strength on Wednesday, as the dollar retreated in the wake of US inflation data. The EUR/USD rate moved up from the 1.000 parity level, reaching 1.010. The 1.000 level is a psychological support level and the EUR/USD pair is currently testing this support. If the currency pair goes up, it may encounter resistance at 1.078. If the EUR/USD continues to fall past the parity level, it may find support near the 20-year low of 0.985.

German and French Final CPI data, released on Wednesday were both unchanged from last month at 0.1% and 0.7% respectively and were in line with expectations. EU Industrial Production data climbed to 0.8% from 0.5% last month, exceeding expectations. 

Increasing signs that the Eurozone economy is slowing down and may tip into recession have pushed the single currency down. Struggling Eurozone economies, rampant inflation, and a looming energy crisis in the EU create a toxic combination. 

Concerns of an imminent energy crisis in the Eurozone also keep the Euro down. After the EU announced a gradual ban on Russian oil imports, Russia retaliated by limiting its natural gas exports to certain EU countries. On Monday, the Nord Stream 1 gas pipeline was shut off for routine maintenance until the 21st of July. This is Germany’s biggest single gas pipeline, supplying the country with most of its imported natural gas from Russia. Gas supplies via this pipeline from Russia have already been reduced to 40% and reports that Russia might use the maintenance period to cut off completely gas supplies are pushing the Euro down. 

Worries about high debt levels in some Eurozone countries were revived following the ECB’s announcement to end the quantitate easing program in July. The ECB is struggling to deal with financial fragmentation in the EU caused by the wide range of lending rates across Eurozone states, limiting the ECB’s monetary tightening options.

Stagnating the Eurozone economy increases the odds that the ECB may be forced to moderate its plans for raising interest rates to combat high inflation. In contrast, the Fed’s steep rate hikes in the past few months, emphasize the gap between ECB and Fed policies, putting pressure on the Euro. Eurozone inflation in June has reached a record high of 8.6%, an increase from 8.1% in May, driven primarily by rising food and energy costs. 

EURUSD 1hr chart

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GBP 

The Sterling rallied on Wednesday as the dollar weakened, with the GBP/USD rate fluctuating around the 1.190 level and moving away from a two-year low. If the GBP/USD rate goes up, it may encounter resistance near the 1.233 level, while if it declines, support may be found near 1.140. 

On Wednesday, positive economic data for the UK boosted the Sterling. Several indicators were released on Wednesday, such as GDP, Construction Output, Goods Trade Balance, Index of Services, Industrial Production, and Manufacturing Production. These are indicators of economic health and activity in the UK and overall, the data released exceeded expectations. After a series of disappointing economic data for the UK in the past few weeks, the economic outlook in the UK seems to be improving. GDP in particular climbed to 0.5% from -0.2% last month, far exceeding expectations.

Global recession concerns are putting pressure on the risk-sensitive Sterling. Deteriorating economic health in the UK is keeping the currency down, as Britain’s uncertain economic outlook limits the BOE’s ability to shift towards a more aggressively hawkish policy. Stagflation is a risk for the UK economy, as for many other countries, as economic stagnation is coupled with rising inflation. 

Soaring inflation rates add more pressure on the BOE to continue increasing its interest rates. UK inflation has risen to 40-year highs in June touching 9.1% annually, driven primarily by the high cost of energy imports, putting pressure on UK households.

The BOE is adopting a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. With the Fed moving at an aggressively hawkish pace, the divergence in monetary policy between the Fed and the BOE is highlighted, putting pressure on the Sterling. 

Political instability in the UK is also putting pressure on the pound, after British PM, Boris Johnson’s resignation last week. Johnson’s resignation was considered to be a matter of time and had already been largely priced in by markets. As however, the matter of his succession will have to be decided soon, and there is renewed political uncertainty adding pressure on the Sterling.

GBPUSD 1hr chart

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JPY

The Yen retreated on Wednesday, even as the dollar weakened, with the USD/JPY pair reaching the 137.5 level. If the USD/JPY declines, support might be found near the 134.2 level and further down at 131.7. If the pair climbs it may find resistance at the 1998 high of 147.7. 

Rising global recession fears have sparked a risk-aversion sentiment, boosting safe-haven assets. The dollar has been outperforming competing currencies, such as the Yen. 

The assassination of former Japanese Prime Minister Shinzo Abe ahead of the elections in Japan has affected the political climate in the country and has sent economic ripples throughout the world, triggering a risk-aversion sentiment. The Yen retreated following the assassination of the ex-prime minister, who was campaigning for the upcoming elections when he was shot. 

Japan’s ruling block achieved a sweeping victory on Monday for the Upper House of Parliament. The strong win could help Japan PM Fumio Kishida consolidate his rule and push forward his economic agenda. Kishida has not been a supporter of Abenomics, the economic system established by former PM Abe to boost the economy in Japan. Markets however perceived that Kishida will not move away from the current ultra-easy monetary policy at least in the short-term, and the Yen plummeted. 

The BOJ continues to buy an unlimited amount of Japanese treasury bonds, defending their current low yield.  In contrast, the respective US 10-year bond is offered with a yield of over 3%, more than an order of magnitude higher than the Japanese bond. The large divergence in bond yields makes the low-yielding Yen less appealing to investors than the dollar, pushing its price further down.

The BOJ has kept its benchmark interest rate unchanged, despite the rising inflation rates in Japan. While other countries are moving towards quantitative tightening, Japan continues to pour money into the economy and maintains its negative interest rate. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down. 

Inflation in Japan has remained above the BOJ’s 2% target in June, reaching 2.1% on an annual basis. The combination of a weak currency and rising inflation is burdening Japanese households. 

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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