Important calendar events
The dollar climbed on Thursday, especially after the ECB’s interest rate announcement, with the dollar index rising above 103.2. Bond yields also rose, with the US 10-year treasury note yielding firmly above 3.0%.
US unemployment Claims released on Thursday were higher than expected, showing that employment levels in the US are falling and failing to provide support for the currency. The dollar gained strength from the Euro’s decline on Thursday though, following the ECB monetary policy meeting.
On Thursday, renewed risk aversion sentiment pushed stock markets down, while boosting the safe-haven dollar. Continued Russian hostilities against Ukraine have increased risk-aversion sentiment, providing support for the dollar. As there is still no end in sight to the crisis, the dollar’s appeal as an investment remains high, although risk appetite seems to be gradually returning to markets.
US economic data and Fed rhetoric remain the primary drivers of the dollar. In its latest monetary policy meeting, the US Federal Reserve raised its benchmark interest rate by 50 base points to 1%. Fed rhetoric has become more cautious though, as inflation woes were balanced out by recession fears. FOMC members point to a series of rate hikes of 50 base points each, confirming that the Fed intends to move with a gradual but steady pace towards monetary policy normalization.
Markets have already priced in a series of aggressive rate hikes this year, and the Fed’s more guarded stance recently is causing the dollar to slip. In the coming weeks, the USD price will be affected by US economic, employment, and inflation data, as these will likely determine the aggressiveness of the Fed’s monetary policy tightening. Fed members' speeches will also likely cause volatility in USD price, as market investors will scan these speeches to gauge the US Central Bank’s intentions.
Important economic indicators that are scheduled to be released on Friday for the US, include the monthly CPI and Core CPI data, which are strong indicators of consumer inflation and can affect the Fed’s future monetary policy. US headline inflation in May is expected to have increased to 8.3% and core inflation to 5.9%.
The Euro plummeted on Thursday, following the ECB interest rate decision, with the EUR/USD rate falling below 1.062. If the currency pair goes up, it may encounter resistance at 1.093. If the currency pair falls, it may encounter support at the 1.036 level which represents the 2016 low, and further down near a 20-year low of 0.985.
Clear indications from the ECB that it would move towards a more hawkish policy this year, had bolstered the Euro in the past few weeks, with markets pricing in up to 130 base points rate hikes throughout the year.
The ECB meeting on Thursday came as a disappointment though and the Euro plummeted after the ECB’s announcement. The ECB kept its interest rate unchanged, as expected, putting pressure on the currency. Some market participants were expecting a rate hike though, and markets were pricing in the possibility of a small, 10-base points rate hike.
Even though the EU Central Bank was not widely expected to change its benchmark interest rate at this meeting, the ensuing Monetary Policy Statement was more dovish than expected, driving the Euro down. The ECB pointed to a small rate hike of 25 base points at its next meeting in July, which was more modest than expected, as markets were pricing in an interest rate increase of up to 50 base points.
The ECB has kept its interest rates below zero for over a decade and an increase in interest rates represents a hawkish turn in its monetary policy, to counter unprecedented inflation rates. The ECB has also signaled that it may gradually quicken the pace of monetary tightening, by raising its interest rate by 50 base points in September if inflation doesn’t improve.
Economic growth in the EU has been stalling after the pandemic, raising fears of a potential recession. Even though the ECB has pointed clearly to a shift towards a more hawkish policy, stagnating Eurozone economies limit the ECB’s flexibility to increase interest rates to combat high inflation. CPI estimates, which are leading indicators of consumer inflation, showed that EU inflation is on the rise. Inflation in the Eurozone climbed to record highs, reaching 8.1% in May, driven by rising food and energy costs.
Last week, EU members announced a gradual ban on Russian oil imports. Concerns about rising energy costs in the EU that would bring inflation even higher up are putting pressure on the Euro.
ECB President Christine Lagarde and German Buba President Nagel are due to deliver speeches on Friday, which may affect the Euro, especially in the wake of the ECB’s policy meeting on Thursday.
The sterling retreated on Thursday, as the dollar gained strength, with the GBP/USD rate falling to 1.249. If the GBP/USD rate goes up, it may encounter resistance near the 1.308 level, while if it declines, support may be found near the two-year low at 1.206. The dollar’s rally puts pressure on competing assets, driving the sterling down.
The Sterling has been slipping this week, weighed down by a discouraging economic outlook and political instability. The British PM Boris Johnson faced a vote of no-confidence from within his party on Monday, after the threshold of 15% of the party voted against the UK PM. Boris Johnson won the vote by a margin of 211 to 148, but an unexpectantly large number of Tories voted against him and the political climate in the UK remains tense putting pressure on the currency.
Last week, UK economic data were weak, indicating that the economic outlook for the UK remains discouraging and that the British economy is still sluggish, raising fears of a possible recession. Headline inflation in the UK rose to 9% in April, while core inflation hit 6.2%. Headline inflation reached a new 40-year high, highlighting the need for legislative action to tame soaring inflation rates. 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.
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 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 Yen traded sideways against the dollar on Thursday, with the USD/JPY pair fluctuating around the 134.0 level. If USD/JPY rises, it may find resistance at the 2002 high of 135.3. If the USD/JPY declines, support might be found near the 127 level and further down at the 121.3 level.
The dollar’s recovery this week is making the Yen less appealing to investors as the two currencies are competing as safe-haven assets. The Yen has been losing its status as a safe-haven currency however and has been retreating since the beginning of the year.
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.
On Monday, BOJ Governor Haruhiko Kuroda stated that the Bank’s primary focus was to support the Japanese economy which is still struggling from the impact of the pandemic, and remained emphatically against a monetary policy tightening. Kuroda stressed that the BOJ’s accommodative policy is set to continue, despite Japan’s CPI breaching the BOJ’s 2% target, reaching 2.1% for the first time in seven years. Kuroda stated that Japan’s rising inflation rates are temporary and are mainly due to commodity and energy price rises rather than the result of a growing economy. In addition, Kuroda spoke in favor of a weak yen, although the combination of a weak currency and rising inflation is burdening Japanese households.
Bond yields have fallen across Japan’s treasury curve due to low demand. Japan’s 10-year government bond yielded a 0.24% interest rate at the bond auction on Thursday with a low number of bids made per bid accepted. 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 approximately 2.8%, 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.
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