Important calendar events
The dollar continued climbing early on Wednesday, with the dollar index reaching the 100.50 level, but dropping sharply later in the day, closing at 99.8. Yields also fell across the US treasury curve, with the US 10-year treasury note falling below 2.7% on Wednesday.
US Producer Price data released on Wednesday jumped by 11.2% from last year’s data, marking the biggest increase on record in over a decade. The PPI data are leading indicators of consumer inflation and were higher than expected due to the rise in oil prices, suggesting that US inflation would remain at high levels for some time.
Soaring inflation rates in the US have increased expectations of a high rise in the Fed’s benchmark interest rate, buoying the dollar. CPI data released on Tuesday showed headline inflation in the US rose to 8.5%, its highest rate since 1981, while core CPI (excluding food and energy) came below expectations, at 6.5%.
Over the past couple of weeks, Fed rhetoric has been one of the primary drivers of USD price, as the Fed signals a faster pace of policy tightening in the US. Markets are beginning to price in a steep rate hike of 50 base points at the Fed’s next policy meeting in May. Markets have been pricing in a total of over 225 base points of additional interest rate hikes this year, boosting the dollar.
This week, Fed rhetoric continued raising expectations of a steep rate hike, with FOMC member Evans commenting on Monday that an interest rate rise of 50 base points in May seems highly likely. On Tuesday, FOMC Member Brainard delivered a speech about the economy at an online event hosted by the Wall Street Journal. Brainard emphasized in her speech the importance of bringing down inflation in the US through rate hikes and balance sheet trimming. Brainard was formerly considered one of the more dovish FOMC members and her recent hawkish tones carry extra weight, further boosting the dollar.
FOMC minutes released last week showed that several Fed officials were in favor of a rate hike of 50 base points last month, increasing the chances of a 50 bp increase in the Fed’s benchmark interest rate in May. FOMC minutes also signaled that the US Central Bank would reduce its bond holdings by as much as $95 billion per month.
Reports of escalating violence against Ukraine and increased sanctions on Russia have also turned investors’ interest towards safe-haven assets. On Wednesday, hopes for a resolution of the crisis between Russia and Ukraine were diminished, as Russian President Vladimir Putin announced that diplomatic talks with Ukraine are at a dead end. The Biden administration announced new sanctions last week, targeting Russia’s largest financial institutions to increase economic pressure on Russia.
Several important financial indicators are scheduled to be released on Thursday for the dollar, including Monthly Core Retail Sales and Retail Sales, Unemployment Claims, and Preliminary UoM Consumer Sentiment. In addition, FOMC Member Mester is due to deliver a speech on Thursday, which may cause some volatility for the dollar, as investors pay special attention to FOMC member statements to gain insight into the Fed’s direction ahead of the next policy meeting in May.
EUR/USD rose sharply on Wednesday, reaching the 1.089 level, as the Euro gained strength against the dollar. If the currency pair goes up, it may encounter resistance at 1.118, while if it declines, support may be found at the 1.080 level.
The dollar has been boosted by hawkish Fed rhetoric over the past weeks, as well as by intensifying tensions between Russia and Ukraine, but fell sharply against the Euro on Wednesday, ahead of the ECB policy meeting.
On Thursday, all eyes are going to be on the ECB, which is going to announce its main refinancing rate. Even though the EU Central Bank is not expected to change its benchmark interest rate at this meeting, the ensuing Monetary Policy Statement is going to be scanned closely by market participants and will likely cause some volatility for the Euro. The Euro has weakened over the past few weeks, as markets anticipate a continuance of the ECB’s dovish policy until Q4 of 2022. In case, however, the ECB strikes a more hawkish note at its meeting on Thursday, the currency might regain some of its lost ground.
The Euro rallied on Monday, as the results of the first round of the French Presidential Elections showed Emmanuel Macron to be in the lead, raising hopes of political stability for one of the Eurozone’s leading economies.
Financial data released on Tuesday for the Eurozone included indicators of inflation and economic health and were overall disappointing for the direction of the Eurozone economy. The ZEW Economic Sentiment indicators, in particular, depend mostly on the state of Germany’s economy, which is the EU’s leading economy, and have not shown signs of economic recovery, as hoped for.
A new round of EU sanctions on Russia last week also weighed down the Euro. The new EU sanctions will target the energy sector for the first time, with a ban on coal imports from Russia worth €4bn a year. In addition, Russia’s demands for payments of energy imports in Roubles have increased concerns of an impending energy crisis in Europe, putting pressure on the Euro. Germany has already entered the initial phases of implementing an emergency gas law, preparing for rationing gas resources among its population.
The minutes of the latest ECB meeting released last week indicated that many of the Central Bank’s members have expressed concern about the high inflation levels in the EU and were in favor of taking immediate steps towards monetary policy normalization. The ECB however, is hesitant to raise its interest rates, as the Eurozone economy is still struggling to recover from the effects of the pandemic. The ECB is trying to avert a dangerous economic effect known as stagflation, the mix of economic stagnation and high inflation rates.
The ECB has been pursuing a more cautious fiscal policy than other major Central Banks and does not plan to raise its benchmark interest rate before the end of its bond-buying program in the third quarter of 2022. As the Fed and the BOE have already raised their benchmark interest rates, the Euro remains at a disadvantage from the difference in interest rates.
The Sterling exhibited high volatility on Wednesday, as the release of UK inflation data boosted the currency. The GBP/USD rate was catapulted to the 1.312 level, as the dollar plummeted, while the pound gained strength, propped up by high inflation data. If the GBP/USD rate goes up, it may encounter resistance at the 1.331 level and further up near the 1.341 level, while if it declines, further support may be found near the 1.267 level.
Several important economic data were released on Wednesday for the UK, including Annual CPI and Core CPI, Annual HPI, Monthly PPI Input, and Output. These are key indicators of inflation and showed that inflation rates in the UK were higher than expected, with headline inflation reaching 7%. UK inflation has hit a 30-year high and is expected to rise further in the coming months, with a peak rate close to 9% in Q4.
Rising commodity prices and import costs in the UK are driving inflation rates higher. The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Soaring inflation rates may induce the BOE to adopt a tighter monetary policy to tame inflation. A more hawkish fiscal policy and consecutive rate hikes though, may stifle the country’s economy and are forcing the BOE to perform a balancing act between bringing inflation under control and allowing for economic growth.
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, there are signs that its stance may soften in the coming months, weighed down by a fragile economy. In contrast, the increasingly hawkish Fed rhetoric is boosting the dollar against the pound.
BOE Governor Andrew Bailey has stressed the importance of delivering a clear message to the public regarding the BOE’s future policy. He has stated that the joint effects of COVID and the war in Ukraine on the global economy would take some time to manifest fully and, in the meantime, the BOE would need to remain cautious. Bailey has also warned that the energy crisis in the UK was going to be ‘historic’, displaying a relatively dovish stance these past couple of weeks, especially compared to the more hawkish Fed rhetoric.
Several financial statements are scheduled to be released on Thursday for the sterling, including RICS House Price Balance and BOE Credit Conditions Survey but are not expected to affect the currency significantly.
The Yen plummeted to new lows early on Wednesday, as Monthly Core Machinery Orders and M2 Money Stock data were lower than expected and showed that the economy in Japan is sluggish.
The USD/JPY went above the 126 level on Wednesday, breaking through the resistance level of the 2015 high at 125.8 but retreated later in the day as the dollar fell. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level.
The primary driver of the Yen over the past few months has been the BOJ’s fiscal policy. This week, the Yen has been pushed further down by the persistently dovish stance of the BOJ. Bank of Japan Governor Haruhiko Kuroda delivered a speech on Wednesday at the Trust Companies Association of Japan's annual meeting, in Tokyo. Kuroda acknowledged the impact on the Japanese economy of increased import costs and stressed the BOJ’s commitment to an ultra-easy monetary policy to support the struggling economy.
Kuroda, in an earlier speech on Monday, re-affirmed the BOJ’s commitment to a monetary easing policy and stated that Japan’s economy is recovering from the impact of the pandemic, but stressed that the war in Ukraine has introduced a high level of uncertainty over the country’s economy.
The Bank of Japan has maintained its negative interest rate from -0.10%, while other Central Banks are moving towards a policy normalization after the pandemic and are raising their benchmark interest rates. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.
Last week Kuroda commented on the weakening Yen, expressing concern that recent yen moves have been somewhat rapid. Kuroda however, reiterated the benefits of a weaker Yen especially to Japan’s exports, although he acknowledged the added burden of the weak currency on households.
Japan’s core CPI may climb around 2% in April, similar to other countries that are expected to see a peak in inflation rates around the same time, largely due to the effect of the increase in oil prices. Japan is a net energy importer and the current energy crisis is damaging the country’s terms of trade and overall economic health. The rising cost of oil is causing goods prices to rise in Japan, with oil imports accounting for 80% of the country’s oil consumption.
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