Important calendar events
The dollar climbed to fresh 20-year highs on Tuesday, with the dollar index rising above the 108.5 level early in the day. Global recession concerns are propping up the safe-haven dollar, while competing assets, such as the Euro and the Sterling, are pushed down. US Bond yields firmed on Tuesday, with the US 10-year treasury note yielding approximately 3%.
The global economic outlook is poor, with a recession threatening many countries. Rampant inflation, combined with tightening monetary policy creates a toxic economic mix. Recession fears and geopolitical risks increase risk aversion sentiment, boosting the safe-haven dollar.
Financial indicators released last week for the US created a positive economic outlook, boosting the dollar. Robust financial and employment data show that the US economy is not at imminent risk of recession, increasing the chances of a steep rate hike in July.
In its latest policy meeting, the US Federal Reserve voted to raise its benchmark interest rate by 75 points, taking aggressive action against inflation. High US inflation rates are forcing the Fed to tighten its monetary policy. PPI in June climbed 0.8% for the month and 10.8% on an annual basis, driven by rising costs of food and energy. Another rate hike of 75 base points is expected for July and is already been priced in by markets, catapulting the dollar to record highs. As markets have mostly priced in a steep interest rate hike this month, hawkish Fed rhetoric may need to continue with renewed vigor to boost the dollar further.
CPI and Core CPI data are scheduled to be released on Wednesday, while PPI and Core PPI data are scheduled to be released on Thursday. Together, the CPI and PPI data are expected to paint a clear picture of the current inflation conditions in the US. These data are expected to affect dollar price, as they are key indicators of consumer inflation and may play a decisive role in determining the level of fiscal tightening that the Fed is going to decide on this month.
The Euro slipped on Tuesday, on disappointing EU economic data, with the EUR/USD rate almost touching the 1.000 parity level for the first time in 20 years. The 1.000 level is a psychological support level and the EUR/USD pair is currently testing this support. If the currency pair goes up, it may encounter resistance at 1.078. If the EUR/USD continues to fall past the parity level, it may find support near the 20-year low of 0.985.
Increasing signs that the Eurozone economy is slowing down and may tip into recession have pushed the single currency down. Struggling Eurozone economies, rampant inflation, and a looming energy crisis in the EU create a toxic combination.
On Tuesday, ZEW Economic Sentiment and German ZEW Economic Sentiment data were released, which are key indicators of economic health. These were especially disappointing, showing that the Eurozone economy is slowing down. German ZEW Economic Sentiment plummeted to -53.8, from -28 last month, while ZEW Economic Sentiment fell to -51.1, from -28 last month. These results show a pessimistic outlook for the EU economy, pushing the Euro down.
Concerns of an imminent energy crisis in the Eurozone also keep the Euro down. After the EU announced a gradual ban on Russian oil imports, Russia retaliated by limiting its natural gas exports to certain EU countries. On Monday, the Nord Stream 1 gas pipeline was shut off for routine maintenance until the 21st of July. This is Germany’s biggest single gas pipeline, supplying the country with most of its imported natural gas from Russia. Gas supplies via this pipeline from Russia have already been reduced to 40% and reports that Russia might use the maintenance period to cut off completely gas supplies are pushing the Euro down. In addition, a strike of Norwegian oil and gas workers last week has intensified fears of an energy crisis in the EU.
Worries about high debt levels in some Eurozone countries were revived following the ECB’s announcement to end the quantitate easing program in July. The ECB is struggling to deal with financial fragmentation in the EU caused by the wide range of lending rates across Eurozone states, limiting the ECB’s monetary tightening options.
Stagnating the Eurozone economy increases the odds that the ECB may be forced to moderate its plans for raising interest rates to combat high inflation. In contrast, the Fed’s steep rate hikes in the past few months, emphasize the gap between ECB and Fed policies, putting pressure on the Euro. Eurozone inflation in June has reached a record high of 8.6%, an increase from 8.1% in May, driven primarily by rising food and energy costs.
Several economic indicators are scheduled to be released on Wednesday for the Eurozone, such as French and German Final CPI, Industrial Production, and German 30-y Bond Auction. These may affect the Euro, especially the CPI data, which are key inflation indicators for some of the EU’s leading economies.
The Sterling dropped to a fresh two-year low against the dollar on Tuesday, with the GBP/USD rate falling to the 1.180 level early in the day, before paring some of its losses and climbing back to 1.190. If the GBP/USD rate goes up, it may encounter resistance near the 1.233 level, while if it declines, support may be found near 1.140.
Global recession concerns are boosting the dollar and are putting pressure on the risk-sensitive Sterling. Deteriorating economic health in the UK is keeping the currency down, as Britain’s uncertain economic outlook limits the BOE’s ability to shift towards a more aggressively hawkish policy. Stagflation is a risk for the UK economy, as for many other countries, as economic stagnation is coupled with rising inflation.
Soaring inflation rates add more pressure on the BOE to continue increasing its interest rates. UK inflation has risen to 40-year highs in June touching 9.1% annually, driven primarily by the high cost of energy imports, putting pressure on UK households.
The BOE is adopting a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. With the Fed moving at an aggressively hawkish pace, the divergence in monetary policy between the Fed and the BOE is highlighted, putting pressure on the Sterling.
Political instability in the UK is also putting pressure on the pound, after British PM, Boris Johnson’s resignation last week. Johnson’s resignation was considered to be a matter of time and had already been largely priced in by markets. As however, the matter of his succession will have to be decided soon, and there is renewed political uncertainty adding pressure on the Sterling. The governing party’s main opposition, the Labour Party put forward a motion for a no-confidence vote in Johnson's government on Tuesday, but the motion was blocked by the British Government.
Several important economic data are scheduled to be released on Wednesday for the UK, such as GDP, Construction Output, Goods Trade Balance, Index of Services, Industrial Production, and Manufacturing Production. These are indicators of economic health and activity in the UK and may show the current direction of the British economy.
The Yen exhibited high volatility on Tuesday, gaining strength early in the day, but retreating later, with the USD/JPY pair pushing past the 136.7 level resistance. If the USD/JPY declines, support might be found near the 134.2 level and further down at 131.7. If the pair climbs it may find resistance at the 1998 high of 147.7.
Rising global recession fears have sparked a risk-aversion sentiment, boosting safe-haven assets. The dollar has been outperforming competing currencies, such as the Yen. On Tuesday however, the Yen rallied as it has been trading in oversold territory for some time.
The assassination of former Japanese Prime Minister Shinzo Abe ahead of the elections in Japan has affected the political climate in the country and has sent economic ripples throughout the world, triggering a risk-aversion sentiment. The Yen retreated following the assassination of the ex-prime minister, who was campaigning for the upcoming elections when he was shot.
Japan’s ruling block achieved a sweeping victory on Monday for the Upper House of Parliament. The strong win could help Japan PM Fumio Kishida consolidate his rule and push forward his economic agenda. Kishida has not been a supporter of Abenomics, the economic system established by former PM Abe to boost the economy in Japan. Markets however perceived that Kishida will not move away from the current ultra-easy monetary policy at least in the short-term, and the Yen plummeted.
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 BOJ has kept its benchmark interest rate unchanged, despite the rising inflation rates in Japan. While other countries are moving towards quantitative tightening, Japan continues to pour money into the economy and maintains its negative interest rate. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down.
Inflation in Japan has remained above the BOJ’s 2% target in June, reaching 2.1% on an annual basis. The combination of a weak currency and rising inflation is burdening Japanese households.
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