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Dollar vulnerable to Fed interest rate decision

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Written by:
Myrsini Giannouli

01 February 2023
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Important calendar events

  • JPY: Final Manufacturing PMI
  • GBP: BRC Shop Price Index, Final Manufacturing PMI
  • EUR: Italian, Spanish, French, and German Manufacturing PMI, Eurozone Final Manufacturing PMI, CPI Flash Estimate, Core CPI Flash Estimate, Unemployment Rate
  • USD: ADP Non-Farm Employment Change, Final Manufacturing PMI, ISM Manufacturing PMI, ISM Manufacturing Prices, JOLTS Job Openings, FOMC Statement, Federal Funds Rate, FOMC Press Conference


The dollar dipped on Tuesday as market odds leaned towards a low Fed rate hike on Wednesday and the dollar index dropped to the 102 level. US Treasury yields also declined slightly on reduced rate hike expectations, with the US 10-year bond yielding approximately 3.52%. 

Fed interest rate changes have been the main factor driving the US dollar and treasury yields over the past few months. At the latest monetary policy meeting the Fed raised interest rates by 50 basis points, bringing the benchmark interest rate to a target range of 4.25% to 4.50%. 

Economic activity and health indicators released on Tuesday for the US were overall pessimistic for the US economy. CB Consumer Confidence dropped to 107.1 in January, falling short of expectations of a 109.1 print. Declining business confidence is a sign of a worsening economic outlook.

The Fed monetary policy meeting on Wednesday will likely affect the dollar considerably. Many analysts believe that the Fed will ease its rate hikes 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. 

Market odds are currently in favor of a moderate 25-bp rate hike at Wednesday’s meeting and the dollar will be under pressure if the Fed shifts towards a more dovish policy. Market participants will also be paying close attention to the Fed’s guidance through Fed Chair Jerome Powell’s press conference after the conclusion of the meeting.

US inflation seems to be cooling, as annual PCE dropped to 4.4% in December, against a 4.7% print in November. This is the Federal Reserve’s preferred inflation gauge, and its decline may induce the Fed to pivot towards a more dovish direction in its policy meeting this week. 

In addition, Producer Price Index declined by 0.5% in December, versus estimates of a 0.1% drop. US headline inflation also dropped to 6.5% year-on-year in December from 7.1% in November. Cooling price pressures may give the US Federal Reserve some leeway towards scaling back its interest rate increases, putting pressure on the dollar. 

Advanced quarterly GDP data revealed that the US economy is expanding at a higher rate than anticipated. 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. 

Several economic activities and health indicators are scheduled to be released on Wednesday for the US including, ADP Non-Farm Employment Change, Final Manufacturing PMI, ISM Manufacturing PMI, ISM Manufacturing Prices, and JOLTS Job Openings, and may affect the dollar ahead of the Fed rate decision later in the day. 



The Euro gained strength against the dollar on Tuesday, with EUR/USD climbing to the 1.087 level. If the currency pair goes up, it may encounter resistance at 1.089 and higher up near 1.118. If the EUR/USD pair declines, it may find support at 1.076. 

Economic activity and health indicators released for the Eurozone on Tuesday were overall mixed for the EU economic outlook. German retail sales unexpectedly decreased by 5.3% in December, indicating a slowdown in Europe's largest economy and putting pressure on the Euro. German Unemployment Change went down by 22K in December, though, against expectations of a 5K rise. French Flash GDP for the final quarter of 2022 showed a marginal expansion by 0.1%, versus expectations of a flat print.

This week all eyes are going to be on the Fed and ECB monetary policy meetings, which will likely determine the trend of EUR/USD. The ECB meeting is on February 2nd, a day after the highly anticipated Fed meeting. Markets are pricing in another ECB 50-bp rate this week. On the other hand, market odds for the next Fed rate hike lean towards a 25-bp rate hike, as a pivot in the Fed’s policy is expected. If the Fed adopts a more dovish policy, the Euro is expected to gain strength against the dollar. 

ECB President Christine Lagarde delivered a particularly hawkish speech last week, emphasizing the central bank’s commitment to raising interest rates. Lagarde stated that the ECB will still have to raise interest rates significantly at a steady pace to combat soaring inflation. 

Final 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. EU economic outlook is poor, and the ECB might be forced to raise interest rates in a recessionary backdrop.

Several key indicators are scheduled to be released on Wednesday for the Eurozone including, Eurozone Final Manufacturing PMI, CPI Flash Estimate, Core CPI Flash Estimate, and Unemployment Rate. These may cause some volatility in the price of the Euro ahead of the ECB policy meeting on Thursday.

EURUSD 1hr chart



The Sterling lost strength against the dollar Tuesday and GBP/USD dropped to 1.230. If the GBP/USD rate goes up, it may encounter resistance at 1.244, while support may be found near 1.226. 

The UK’s grim economic outlook is putting pressure on the Sterling. The IMF downgraded the UK’s growth forecast, predicting that the British economy will contract by 0.6% this year. Economic activity and health indicators released on Tuesday for the UK were also pessimistic, driving the Sterling further down. M4 Money Supply, which reflects the change in the total quantity of domestic currency, dropped by 0.8% in December, against expectations of a 1.2% growth. Mortgage approvals and Net Lending were also down, indicating that the British economy is in a state of stagnation. 

This week, the all-important Fed and BOE monetary policy meetings will take place on February 1st and 2nd respectively. Market participants will pay special attention to both meetings and their outcome is likely to affect the GBP/USD rate considerably. Markets are pricing in another 50-bp rate hike this week, but traders will also focus on the forward guidance given by the BOE. The Fed on the other hand is expected to be less aggressive in its tightening regime, voting for a 25-bp increase, which will likely boost the Sterling against the dollar.

At the latest monetary policy meeting in December, BOE members voted to hike rates by 50 bps bringing its interest rate to 3.50%. With inflation remaining above 10%, this was perceived by many analysts as the start of a pivot towards a more dovish fiscal policy. 

BOE Governor Andrew Bailey last week appeared to be optimistic about British inflation this year, stating that a corner has been turned in UK inflation and appearing confident that inflation rates will continue to decline.

UK inflation data last week seemed to bare out Bailey’s optimism. PPI data were released for two months, November and December. PPI Input dropped by 0.2% in November from an increase of 0.9% in October, and in December, consumer inflation cooled even further, decreasing by 1.1%. Similarly, PPI output data released for November and December showed that British manufacturers unexpectedly lowered their prices over the past two months. PPI Output printed at -0.1% in November from 0.9% in October and at -1.1% in December, suggesting that inflation may be easing. In addition, UK headline inflation dropped to 10.5% in December from 10.7% in November. 

The UK’s grim economic outlook may limit policymakers’ ability to increase interest rates sufficiently to rein in inflation. The final GDP print for the third quarter of 2022 was -0.3%, indicating that the economy in the UK is shrinking. The British economy is still struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down. 

BRC Shop Price Index and Final Manufacturing PMI data are due on Wednesday for the UK. Market interest this week, however, is going to be mainly on the Fed and BOE meetings.

GBPUSD 1hr chart



The Yen gained strength against the dollar on Tuesday, with USD/JPY dropping below the 130.0 level. If the USD/JPY pair declines, it may find support near 127.2 and further down at 114.2. If the pair climbs, it may find resistance at 131.6.

Economic activity and health data released on Tuesday for Japan were mostly optimistic, boosting the Yen. Retail sales went up by 3.8% on an annual basis, versus the 3.2% expected. Consumer Confidence rose to 31.0 in January from 30.3 in December, versus a print of 30.5 expected.

Japanese policymakers maintained ultra-low interest rates at the BOJ’s January meeting, keeping the central bank’s refinancing rate at -0.10% as expected. BOJ Governor Haruhiko Kuroda defended the central bank's decision to keep its yield curve control policy unchanged and vowed to conduct unlimited bond buying to maintain the bank’s yield curve control. 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 BOJ caused a stir in markets in its previous meeting in December by changing its yield control target for the 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 increase interest rates, cutting off some of its monetary stimuli.

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. 

The final GDP Price Index for the third quarter of 2022 showed economic contraction by 0.3% on an annual basis and the Japanese economy shrank by 0.2% in the third quarter of 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.

Final Manufacturing PMI data are scheduled to be released on Wednesday for Japan. The USD/JPY pair though will be primarily affected by the outcome of the Fed meeting. A 25-bp rate hike is priced in by markets, which may drive the dollar even lower.

USDJPY 1hr chart


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Written by:
Myrsini Giannouli

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