Important calendar events
The dollar dipped early on Wednesday, and the dollar index touched the 104.1 level but pared losses later in the day, climbing to 104.5. US Treasury yields gained strength, with the US 10-year bond yield rising above 4.0%.
US ISM Manufacturing PMI climbed slightly to 47.7 in February from 47.4 in January but did not meet expectations of a higher rise to 47.9. Manufacturing PMI remained below 50, which is contractionary territory for the sector.
US inflation data last week showed that price pressures in the US remain high and are not easing at the pace anticipated. Core PCE, which is the Fed’s primary inflation gauge, came in hotter than expected, rising by 0.6% in January against predictions of a 0.4% raise.
US headline inflation in January dropped to 6.4% year-on-year versus the 6.2% expected. PPI data also surprised markets to the upside, rising by 0.7% in January against expectations of a 0.4% raise and a 0.2% drop in December. Recent US inflation data highlight the risk of inflation becoming entrenched. Sticky inflation may induce the Fed to rethink its recent dovish pivot.
Minutes of the latest Fed meeting indicate that FOMC members believe there is still more work to tackle inflation. Even though FOMC members were in favor of reducing the pace of rate hikes, a pause in the central bank’s tightening policy does not seem to be on the cards just yet.
The Federal Reserve raised interest rates by only 25 basis points at its February meeting, bringing the benchmark interest rate to a target range of 4.50% to 4.75%. Rate hikes have become less aggressive and may continue at their current pace, but the Fed might raise interest rates for longer than previously expected. This means there are likely still a few rate hikes ahead, which may support the dollar. Current market odds lean towards further tightening in the upcoming Fed meetings and an increase in interest rates up to 5.25%.
Preliminary GDP for the final quarter of 2022 was disappointing, showing that the US economy expanded by 2.7% against a 2.9% growth expectation.
On the data front, important employment indicators are due on Thursday for the US, including, Unemployment Claims, Revised Nonfarm Productivity, and Revised Unit Labour Costs.
The Euro gained strength against the dollar on Wednesday, with EUR/USD climbing to 1.069. If the currency pair goes up, it may encounter resistance near 1.070. If the EUR/USD pair declines, it may find support at 1.053.
Eurozone Final Manufacturing PMI data on Wednesday fell in line with expectations, remaining at 48.5 in February, which was the same as January’s reading. The manufacturing sector in the Eurozone continues to contract, remaining below the 50 threshold that denotes industry expansion. The manufacturing sectors of Spain and Italy expanded in February, exceeding expectations, but contracted for France and Germany, which are the EU’s leading economies. Preliminary German CPI in February remained at 8.7%, against expectations of 8.5%. Inflation remains high in most EU countries, adding pressure on the ECB to raise interest rates.
German Buba President Nagel delivered a hawkish speech on Wednesday, boosting the Euro. Nagel stated that inflation in the Eurozone remains persistent, stressing that further rate hikes should be expected beyond March.
Final Annual CPI data released last week for the Eurozone were in line with expectations, showing that headline inflation rose slightly in January to 8.6% on an annual basis, from 8.5% in December. Core CPI, which excludes food and energy, surprised to the upside, hitting a record high of 5.3% against the 5.2% expected. Sticky price pressures in the Eurozone are likely to affect ECB policy, forcing the EU Central Bank to continue raising interest rates.
EU Economic Forecasts indicate that the EU economic outlook appears to be improving, with an upgraded growth forecast for 2023. The EC lifted their growth outlook for 2023 to 0.9%, indicating that the Eurozone will narrowly avoid entering recession and the economy is slowly expanding. Inflation expectations were also downgraded, with headline inflation now expected to fall to 5.6% in 2023. Flash EU GDP data for the final quarter of 2022 confirmed the EC’s forecast, showing that the Eurozone economy expanded by 0.1%.
The ECB raised interest rates by another 50 bp at its February meeting, bringing its main refinancing rate to 3.0%. ECB President Christine Lagarde has emphasized that the central bank aims to bring inflation down to its 2% target. Lagarde confirmed that another 50-bp rate hike would follow at the next monetary policy meeting in March, after which the ECB would re-evaluate its policy. Market odds are currently favoring an increase of the ECB refinancing rate to 4.0% by June.
Eurozone inflation data on Thursday are expected to have some impact on the Euro after last week’s data showed that price pressures in the Eurozone remain high. Flash CPI Estimates are scheduled to be released on Thursday for February and will likely lead the direction of EU inflation.
The Sterling traded sideways against the dollar on Wednesday, with GBP/USD oscillating around the 1.203 level. If the GBP/USD rate goes up, it may encounter resistance near 1.214, while support may be found near 1.192.
European Commission President Ursula von der Leyen met with Prime Minister Rishi Sunak earlier in the week and managed to strike a new Brexit deal. The newest version of the Northern Ireland Protocol, known as the Windsor Framework, contains more favorable trading conditions for the UK, boosting the Sterling.
Economic activity data released on Wednesday for the UK were slightly optimistic, providing support for the Sterling early in the day. M4 Money Supply, which shows the change in the total quantity of domestic currency in circulation and deposited in banks, increased by 1.3% in January against the 0.9% drop expected. Mortgage approvals in January rose to 40K versus the 37K predicted. British Final Manufacturing PMI in February fell in line with expectations, rising slightly to 49.3 from 49.2 in January, but remaining below the 50 threshold that indicates industry expansion.
BOE Governor Andrew Bailey delivered a speech on Wednesday that markets perceived as dovish, driving the Sterling down. Bailey’s stance was cautious and non-committal, stating that nothing has been decided as yet regarding BOE’s future policy. Bailey refused to commit to further rate hikes but did not rule out the possibility that further rate increases might be necessary.
BOE members continue to be divided on the central bank’s future policy direction and market expectations on the outcome of the next policy meeting fluctuate. The BOE raised interest rates by 50 bp at its February meeting, bringing the official bank rate to 4.0%. Markets are currently pricing in a 25-bp rate at the next BOE policy meeting. Several market participants though believe that the British central bank will pause rate hikes completely.
UK headline inflation cooled at a higher pace than anticipated, dropping to 10.1% year-on-year in January from 10.5% in December. Cooling inflation rates remove some of the pressure on the BOE to continue its economic tightening.
Recent GDP data showed that the British economy is slowing down. The British economy contracted by 0.5% in December, which was more pessimistic than the 0.3% expected. Preliminary GDP for the final quarter of 2022 showed stagnation, while GDP for 2022 came in at 4.1%. The IMF downgraded the UK’s growth forecast, predicting that the British economy will contract by 0.6% this year, which is also consistent with BOE forecasts.
The UK’s grim economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The British economy is struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down.
USD/JPY dropped to 135.3 in early trading on Wednesday but pared losses later in the day, climbing to 136.2. If the USD/JPY pair declines, it may find support near 134. If the pair climbs, it may find resistance at 138.2.
Final Manufacturing PMI data released on Wednesday only marginally exceeded expectations, rising to 47.7 from 47.4 in March. Against 47.4 expected. The manufacturing sector in Japan continues to show contraction, with the indicator remaining firmly below 50, which is the threshold for industry expansion.
The Yen has been exhibiting high volatility over the past couple of weeks as developments on the succession of the BOJ Governor are front and center in the news. Incumbent BOJ Governor Kuroda is a staunch supporter of an ultra-loose monetary policy and his term in office expires in April. Japanese Prime Minister Fumio Kishida nominated former BOJ member Kazuo Ueda for the post of BOJ governor last week. Ueda is an academic economist, and his stance is seen as more pragmatic rather than ultra-dovish.
Most market analysts consider that Ueda will likely not be in a hurry to unwind the BOJ’s ultra-easy policy, but as yet his intentions remain unclear. Ueda appeared before the Japanese government's lower house known as the Diet on Friday and again on Monday. Markets eagerly awaited his testimony for signs of a BOJ policy pivot, but Ueda remains non-committal. Upcoming BOJ Governor Ueda hinted at the possibility of tweaking the central bank’s bond yield curve control. However, he cautioned against sudden changes in monetary policy.
BOJ Deputy Governor Shinichi Uchida also reinforced the notion that drastic policy changes should not be expected any time soon. Uchida defended the central bank’s monetary policy stance and stated that the BOJ must maintain monetary easing. Market expectations of a departure from ‘Abenomics’ have been disappointing, driving the Yen down.
Japanese policymakers maintained ultra-low interest rates at the BOJ’s January meeting, keeping the central bank’s refinancing rate at -0.10%. Preliminary GDP data for the final quarter of 2022 showed a minimal economic expansion of 0.2%. Japan’s poor economic outlook raises recession concerns for the world’s third-biggest economy.
Headline inflation in Japan has exceeded the BOJ’s 2% target, touching 40-year highs and putting pressure on businesses and households. Increased price pressures and wages, raise concerns of a wage-price spiral and may force the BOJ to pivot towards a more hawkish policy.
Volatility in Yen price is expected this week due to developments regarding the imminent change in BOJ leadership especially following Ueda’s highly-anticipated testimony before the Diet on Monday. Important economic data due on Thursday for Japan include Capital Spending, Monetary Base, and Consumer Confidence.
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