Important calendar events
The dollar continued gaining strength on Tuesday, as the dollar index was catapulted to a fresh 20-year high of 110.5. US Treasury yields also, climbed, with the US 10-year bond yield climbing above 3.3%.
Increased risk aversion sentiment on Tuesday propped up the safe-haven dollar, which reigns supreme against competing assets. The looming energy crisis in Europe and renewed recession fears have soured risk sentiment this week, boosting the dollar.
US economic activity data released on Tuesday were mixed overall. Final Services PMI data fell to 43.7 on Tuesday from 44.1 last month. ISM Services PMI data though climbed to 56.9 from 56.7 last month.
US inflation remains at a multi-decade high of 9.1%, but its ascend seems to have been arrested for the time being, mainly due to a slowdown in energy costs. Cooling inflation shows that the Federal Reserve’s aggressively monetary tightening yields results and removes some of the pressure on the Fed to increase interest rates.
Fed rhetoric remains hawkish, indicating that the Fed is committed to increase interest rates until inflation has been brought under control. Markets are pricing in a significant Fed rate hike for September, as market odds are leaning towards a 75-bp rate hike.
The Fed is tasked with battling soaring inflation without the benefit of a strong economic background. US economic data in the next few weeks are expected to affect the Fed’s interest rate decision. A robust economic outlook is required to enable the Fed to tighten its monetary policy further.
FOMC Members Mester, Barr, and Brainard are due to deliver speeches on Wednesday, which are expected to affect the dollar. Fed rhetoric is one of the primary drivers of the dollar, especially before the important Fed meeting in September.
The Euro remained firmly below the parity level with the dollar on Tuesday for the second day, as the dollars ascend has been pushing competing currencies down. The dollar index was catapulted to a fresh 20-year high of 110.5 on Tuesday, as risk sentiment soured. The EUR/USD rate continued trading below the parity level throughout the day, going as low as 0.986. The parity level is strong psychological support, which is not easy to overcome. After breaching the parity level, the currency pair may plummet even further. If the EUR/USD continues to decline, it may find support at the 0.845 level, representing the 2002 low. If the currency pair goes up, it may encounter resistance at 1.019 and further up at 1.036.
Europe is facing an energy crisis, which seems to be escalating, driven by the EU’s dependency on Russian energy. G7 finance ministers have agreed to impose a cup on Russian oil prices in an attempt to reduce Russia's ability to fund its war against Ukraine. Gazprom has shut down the Nord Stream 1 gas pipeline in retaliation, leaving the EU vulnerable to the winter ahead and plunging the EU deeper into the energy crisis, spreading fears of energy rationing and blackouts. High energy costs in the Eurozone are driving the Euro down, while inflationary pressures mount.
Eurozone headline CPI jumped to 9.1% on an annual basis in August, the highest on record. Inflation in the EU is expected to rise even further in the following months, possibly reaching double digits, driven by the high cost of energy in the Eurozone. Increased price pressures are forcing the ECB to take swift action to tackle inflation. Rising Eurozone inflation is expected to figure largely in determining the future ECB monetary policy.
In its latest policy meeting, the ECB raised its interest rate by 50 base points, bringing its benchmark interest rate to 0%. The ECB’s interest rate remains low, especially compared to the Fed’s 2.50% interest rate. The economic outlook in the EU remains poor, however, limiting the ECB’s ability to raise interest rates.
This week, all eyes are going to be on the ECB and its much-anticipated policy meeting on the 8th. Reports of a steep rate hike of 75 bps in Thursday’s meeting are boosting the Euro. ECB members’ speeches at the recent Jackson Hole Symposium were more hawkish than anticipated, fuelling expectations of a shift towards a tighter monetary policy.
Minor economic indicators are scheduled to be released on Wednesday for the Eurozone, which may affect the currency ahead of the ECB meeting.
The Sterling was volatile on Tuesday, driven by conflicting market forces. On one hand, the dollar continued its ascend, putting pressure on competing currencies. On the other hand, the GBP was propped up by the first glimmer of hope for political stability in months, as well as by optimistic economic data for the British economy.
GBP/USD rose above 1.160 on Tuesday, but pared its gains later in the day, falling back to 1.150. If the GBP/USD rate goes up, it may encounter resistance near the 1.190 level, while if it declines, support may be found near 1.140, representing the 2020 low.
The Sterling posted its worst monthly low in August since 2016, pushed down by Britain’s grim economic outlook and political instability. On Monday the British pound had retreated to its lowest level since 1984, ahead of the Tory election results.
A climate of political uncertainty has been putting pressure on the GBP over the past few months, especially after former PM Boris Johnson’s resignation in July. On Tuesday, Former Foreign Secretary Liz Truss formally became UK’s next Prime Minister, bringing a measure of stability and propping up the Sterling.
UK Construction PMI data posted on Tuesday exceeded expectations, rising to 49.2 from 48.9 last month. The optimistic PMI data were unexpected and provided support for the currency since a drop to 48.0 was expected last month.
The latest UK GDP data have shown that the British economy is contracting, confirming the BOE’s forecast of reduced economic growth. 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%.
Britain’s poor economic outlook is preventing a more hawkish fiscal policy and is hampering the BOE’s attempts to bring inflation down. UK inflation reached double digits in July, with CPI climbing to 10.1% on an annual basis and is expected to rise even higher in the following months. Soaring energy and food prices put pressure on British households.
In its latest monetary policy meeting, the Bank of England decided to raise its interest rate by 50 base points, bringing the total interest rate up to 1.75%. The BOE has adopted a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. Markets are pricing in a rate hike of at least 50 bp at the next BOE policy meeting in September.
The release of the Monetary Policy Report Hearings on Wednesday is likely to affect the Sterling, in anticipation of the next BOE policy meeting next week.
The Yen plummeted on Tuesday, as the dollar reached a fresh 20-year high. The USD/JPY rate was catapulted to a 24-year high, reaching above the 142 level. If the USD/JPY pair falls, support might be found near 138.0 and further down at 134.2. If the pair climbs, it may find further resistance at the 1998 high of 147.7.
Japanese Finance Minister Shunichi Suzuki stated on Tuesday that sharp yen moves were "undesirable" and that he was monitoring market volatility with a great sense of urgency. Average Cash Earnings and Household Spending data released on Tuesday for Japan fell below expectations, driving the Yen further down. Household spending fell to 3.4% from 3.5% last month and was considerably lower than the forecasted 4.2%. The Japanese 30-year bond yielded 1.24% on Tuesday, while the corresponding US bond yielded almost 3.5%.
The increased divergence between the US and Japanese monetary policies has widened the gap between their respective bonds, putting pressure on the Yen. Risk sentiment has soured in the past couple of weeks on increased Fed rate hike expectations. US Fed officials are displaying an aggressively hawkish stance, increasing the odds of a steep rate hike in September.
The BOJ maintains 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.
Inflationary pressures are increasing in Japan, mainly due to the high cost of imported energy. The combination of a weak currency, low wages, and rising inflation is burdening Japanese households.
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