Important calendar events
The dollar reached a 20-year high last week, with the dollar index climbing to 104.97. The US dollar has been rising, surpassing its pandemic high of 2020, supported by hawkish Fed monetary policy and strong inflationary pressures. US yields also remained high last week, with the US 10-year treasury note yielding above 3%.
The dollar pared some of its gains on Monday though, with the dollar index falling to 104.2, pushed down by disappointing economic data. The USD, which has been moving into overbought territory, softened on Monday, while US yields also withdrew, with the US 10-year treasury note yielding close to 2.85%.
Fed member John Williams stated on Monday that tackling high inflation rates should be the Fed’s top priority. His speech run along the same lines of recent Fed rhetoric though and failed to provide an additional boost for the dollar. In addition, US Empire State Manufacturing data released on Monday were much lower than expected, putting pressure on the dollar.
PPI data released for the US last week showed that wholesale inflation rose by 0.5% last month and by 11% year to year in April. Producer prices keep rising, indicating that inflation rates are accelerating in the US. US CPI data also exceeded expectations, showing that US inflation is not slowing down as much as forecasted, with consumer prices rising at an annual pace of 8.3% in March. Inflation rates in the US are expected to rise even further, as April’s inflation rates are going to reflect the recent rise in energy prices.
The dollar has been boosted by hawkish Fed policy and increased risk-aversion sentiment. Continued Russian hostilities against Ukraine have increased risk-aversion sentiment these past two months, providing support for the safe-haven dollar. As there is still no end in sight to the crisis, the dollar’s appeal as an investment remains high.
In its latest monetary policy meeting, the US Federal Reserve raised its benchmark interest rate by 50 base points to 1%. This is the first time that the Fed has performed such a steep rate hike since 2000. The Fed has also announced that it would move towards a policy of gradual quantitative tightening. The Fed’s balance sheet has risen to approximately 9 trillion USD during the pandemic and the US Central Bank has decided to start trimming its balance sheet.
Several financial indicators are scheduled to be released for the US on Tuesday, including Core Retail Sales, Retail Sales, Capacity Utilization Rate, Industrial Production, and Business Inventories. Retail Sales data are especially important as they reflect the change in economic activity and may affect the dollar.
In addition, several FOMC Members are due to deliver speeches on Tuesday, along with Fed Chair Jerome Powell and their speeches may cause some volatility for the dollar, as Fed rhetoric has been supporting the dollar for the past few weeks.
The Euro traded sideways against the dollar on Monday, with EUR/USD fluctuating around the 1.040 level. The outlook for the pair is still bearish, but if the currency pair goes up, it may encounter resistance at 1.093 and further up at 1.118. If the currency pair falls, it may encounter support at the 1.036 level which represents 2016 low and further down near a 20-year low of 0.985.
Increased risk-aversion sentiment and hawkish Fed policy have boosted the dollar at the expense of other currencies, with the Euro suffering heavy losses these past few weeks. Fears of an energy crisis in the EU also keep the Euro down, as the EU is expected to announce an oil ban on Russian oil imports. In addition, Russian gas sanctions on the EU were announced last week, added to inflationary and economic pressures, weighing down the Euro.
On Monday however, the dollar softened, while the Euro rallied a little. EU economic forecasts released on Monday showed that Eurozone inflation forecasts were increased to 6.1% in 2022, while growth projections were lowered. Even though economic conditions in the EU are not improving as much as expected, high inflation rates support the Euro, as they increase the chances of an ECB rate hike later in the year.
In addition, ECB Member Francois Villeroy stated on Monday that he is in favour of a decisive June meeting and that an active summer should be expected in terms of the ECB’s monetary policy, further raising expectations of a shift towards a more hawkish policy.
Many of the ECB’s members have repeatedly expressed concern about the high inflation levels in the EU and are in favour of taking immediate steps towards monetary policy normalisation. ECB President Christine Lagarde is in favour of a more dovish stance but has recently shown signs of wavering, stating that the ECB will likely end its bond-buying programme in the third quarter of 2022 and a rate hike might follow just a few weeks later.
ECB members are starting to agree on a more hawkish policy starting in the third quarter of the year and the consensus between them seems to be that the ECB will perform its first rate hike in decades at its next policy meeting in July. The US Federal Reserve has raised its benchmark interest rate by 50 base points to 1%, highlighting the difference in monetary policy between the EU and the US and has been driving the Euro down.
German CPI data released last week were at 7.4%, showing an incremental rise in inflation rates in the Eurozone as the effect of the increase in energy prices is starting to show in April’s inflation data. Eurozone CPI flash inflation estimates have risen by 7.5% on an annual basis, highlighting the problem of rising energy and commodity prices in the EU. Core CPI estimates rose to 3.5%, further increasing the likelihood of an ECB rate hike in July. Markets are pricing in 3 ECB rate hikes this year, of at least 25 base points each.
Several economic indicators are scheduled to be released on Tuesday for the Euro, including the Italian Trade Balance, Flash Employment Change and Flash GDP. In addition, ECB President Christine Lagarde is due to deliver a speech at a charity event in Germany and some volatility is expected for the Euro as traders eagerly await Lagarde’s statements.
The sterling has been under pressure for the past few weeks, falling against the dollar. Early on Monday, the GBP/USD continued trading low, testing its 1.225 support. Later in the day, however, the dollar retreated, while the sterling rallied, with GBP/USD climbing to 1.232. If the GBP/USD rate goes up, it may encounter resistance at the 1.263 level and further up near the 1.331 level, while if it declines, support may be found near the two-year low at 1.206.
UK Monetary Policy Report Hearings took place on Monday, at which the BOE Governor and several MPC members testified on inflation and the economic outlook before the Parliament's Treasury Committee. BOE Governor Andrew Bailey admitted that the Bank is facing its biggest inflationary test in 25 years and defended the BOE’s policy regarding soaring inflation rates in the UK.
The sterling has been losing ground against the dollar due to the divergence in monetary policy between the Fed and the BOE. Although the BOE started the year with a strong hawkish policy, it has recently backed down and moderated its stance, weighted down by the still fragile British economy. In contrast, the increasingly hawkish Fed policy is boosting the dollar against the pound.
In its latest monetary policy meeting, the Bank of England raised its benchmark interest rate by 25 base points, bringing its rate to a 13-year high of 1%. The BOE stressed once more the dangers of recession, as the economic contraction is battling with inflation rates that are predicted to surge to 40-year highs of 10% in the coming months. The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Stagflation is a risk for the UK economy, as for many other countries, as economic stagnation coupled with rising inflation creates a toxic mix for the economy.
Brexit issues have come once again into the foreground after elections to the Northern Ireland Assembly. Last week, the EU rejected the latest UK proposal regarding the Northern Ireland protocol and the situation could trigger Article 16 of the Brexit deal, adding pressure to the pound.
Several economic data are scheduled to be released on Tuesday for the sterling, such as the Average Earnings Index, Claimant Count Change, and Unemployment Rate. These are indicators of economic health and employment status in the UK and may affect the currency.
In addition, MPC Member Cunliffe is due to deliver a speech on Tuesday. His speech may cause some volatility for the sterling as it may provide insight into the BOE’s future monetary policy direction especially following the UK Monetary Policy Report Hearings on Monday.
The USD/JPY pair traded sideways on Monday, fluctuating around the 129 level, pushed down by the weakening dollar. If USD/JPY continues to rise, it may find resistance at the 2002 high of 135.3. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level.
On Monday, the annual PPI in Japan rose to 10% for April and was higher than expected, indicating that inflation rates are rising in Japan, mostly due to the rising costs of imported energy.
The Yen has been retreating for months, with market investor interest in the currency slowing down, despite global economic risks. The currency, which has been oversold, regained some of its lost ground at the end of last week, but the outlook for the USD/JPY pair remains bullish.
Bond yields fell across Japan’s treasury curve last week, giving weak results, due to low demand. Japan’s 10-year government bond yield auction last week maintained the 0.25% interest rate as 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 primary driver of the Yen over the past few months has been the BOJ’s fiscal policy, with the BOJ following an ultra-easy monetary policy to support the struggling economy. While other countries are moving towards quantitative tightening to return to pre-pandemic fiscal policies, Japan continues to pour money into the economy and maintains its negative interest rate. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.
The safe-haven dollar is boosted by continuing Russian hostilities against Ukraine. The Yen is also considered a safe-haven currency but has been underperforming, despite an increased risk-aversion sentiment, and many investors have been doubting its safe-haven status.
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