Important calendar events
The dollar continued to retreat on Monday, with the dollar index falling below the 106.5 level. US Bond yields remained steady on Monday, with the US 10-year treasury note at approximately 2.8%.
Increased risk appetite on Monday pushed the safe-haven dollar down, while riskier assets were boosted. The dollar has been pulled back from the previous week’s 20-year highs, as it had been trading in overbought territory. Contracting economic activity, declining consumer confidence, rising unemployment, and high inflation rates paint a grim picture of the economic outlook in the US, pushing the dollar down.
US economic activity seems to be slowing down, indicating that the US economy is still fragile and may not be able to withstand aggressive tightening. Signs that US inflation may be starting to ease also contribute to reducing Fed rate hike expectations.
The Federal Reserve has so far prioritized bringing down inflation rates by sharply raising interest rates. Markets were pricing in an ultra-high rate hike of 75 to 100 bps for July in the past few weeks. Fed rhetoric has been more cautious, however, these past couple of weeks. Markets are now trimming rate hike bets following less hawkish Fed rhetoric, with odds in favor of a 75-bps rate hike or less at the next Fed policy meeting this week.
The much-anticipated Fed monetary policy meeting is scheduled for the 27th and its outcome is expected to considerably affect the dollar price. The Fed is faced with the difficult task of battling soaring inflation without the benefit of a strong economic background. The Fed is expected to raise its interest rate sufficiently to rein in inflation, without crippling the economy. On Wednesday, traders will be poised to react not only to the announcement of the Fed interest rate but also to the FOMC statement and press conference. These may provide hints into the Fed’s future policy direction and outlook.
Several economic indicators that may affect the dollar are scheduled to be released on Tuesday. The Consumer Confidence index especially may affect the dollar, ahead of the Fed meeting.
The Euro gained a little strength on Monday, with the EUR/USD rate climbing to 1.025. If the currency pair goes up, it may encounter resistance at 1.027 and further up at 1.050. If the EUR/USD withdraws, it may find support at the parity level of 1.000, and further down near the 20-year low of 0.985.
The dollar retreated on Monday as risk appetite returned to markets, but the Euro failed to take advantage of the dollar’s weakness. Struggling Eurozone economies, rampant inflation, and a looming energy crisis in the EU create a toxic combination. On Monday, German and Belgian Business Climate data fell considerably below expectations, indicating that the economic outlook in the Eurozone is not improving.
Concerns of an imminent energy crisis in the Eurozone keep the Euro down, as Russia is limiting its natural gas exports to certain EU countries. Nord Stream 1, Germany’s biggest gas pipeline, was shut off for routine maintenance, which was delayed under various pretexts. Gas supply via this pipeline was finally resumed late last week. On Monday however, reports that the pipeline runs at 20% capacity further exasperated the EU’s energy crisis, holding the Euro down.
The EUR/USD pair briefly breached the parity level a couple of weeks ago for the first time in 20 years, as the dollar climbed to a 20-year high and the euro retreated. Last week though, the Euro was boosted by the ECB’s unexpected decision to raise interest rates by 50 base points, since a rate hike of only 25 bps was priced in by markets.
Thursday’s rate hike was the ECB’s first interest rate rise since 2011, bringing the ECB rate from -0.50% to 0%. A Fed rate hike of 75 bps this week is priced in by markets, emphasizing the gap between ECB and Fed policies, putting pressure on the Euro as markets have had time to adjust to last week’s ECB rate hike.
The ECB also announced details of its plan to deal with fragmentation in the Eurozone at Thursday’s meeting. The Transmission Protection Instrument (TPI), as the anti-fragmentation tool is called, aims to balance out economic differences caused by the wide range of lending rates across Eurozone states. This tool will be a new bond-purchasing program, designed to help member states with higher borrowing costs.
The new anti-fragmentation tool may come into play sooner than expected, as political turmoil mounts in Italy. Last week, the ruling coalition fell apart and Prime Minister Mario Draghi offered his resignation. Italian President Sergio Mattarella did not accept Draghi’s resignation at first but was forced to call for early elections after Draghi failed to bring the coalition back together. Italian bond yields jumped and the gap between German and Italian borrowing costs widened. So far, however, the EU seems unprepared to deal with the looming debt crisis in Italy.
The Sterling gained strength against the dollar on Monday, with the GBP/USD rate climbing above the 1.206 level. If the GBP/USD rate goes up, it may encounter resistance near the 1.219 level, while if it declines, support may be found near 1.176.
The Sterling benefitted from increased risk appetite on Monday, although Political instability after British PM Boris Johnson’s resignation is keeping the currency down. The Tory Leadership race continues, with polls showing Foreign Secretary Liz Truss firmly in the lead against Rishi Sunak. In case Truss wins the party leadership, the Sterling may retreat further. Although Truss is known to hold a hawkish stance on issues such as tax cuts, Brexit, etc., she has also cited BOJ policy as a model for future BOE fiscal policy.
The next BOE monetary meeting is scheduled for August, and markets are pricing in a 50-bps rate hike. 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 soaring inflation rates add more pressure to the BOE to continue increasing its interest rates. UK CPI skyrocketed to 9.4% on an annual basis in June from 9.1% in May, driven primarily by the high cost of energy imports, putting pressure on UK households.
The BOE has so far been adopting a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. The Fed, on the other hand, is moving at a more hawkish pace, as a Fed rate hike of at least 75 bps is priced in by markets this week.
Key drivers for the sterling this week will likely be the outcome of the Fed meeting on the 27th, as well as the latest developments on the political front.
The Yen retreated on Monday, pushed down by a bout of increased risk appetite. The USD/JPY pair resumed its ascent, climbing to the 136.6 level. 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 near 139.4 and further up at the 1998 high of 147.7.
The BOJ policy meeting last week held a few surprises. The BOJ kept its main refinancing rate at -0.10%, maintaining its ultra-easy monetary policy. The BOJ also kept its 0.25% yield cap on 10-year Japanese government bonds. US 10-year bonds yield over a magnitude more than corresponding Japanese bonds, presenting a more lucrative option to investors.
Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. The Fed is expected to raise its interest rates again considerably this week to tackle skyrocketing US inflation, with a 75 bps Fed rate hike being priced in by markets. Other major Central Banks are also tightening their monetary policy, with the ECB raising its interest rate unexpectedly by 50 bps last week. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down.
The BOJ upgraded its inflation forecast to 2.3%, up from 1.9% in April, providing some support for the currency. Inflation in Japan remains above the BOJ’s 2% target, reaching 2.2% on an annual basis, according to National Core CPI data for Japan released on Friday.
The BOJ also trimmed this year’s growth forecast to 2.4% from 2.9%, highlighting Japan’s poor economic outlook, with wages showing their biggest decline in two years. The combination of a weak currency, low wages, and rising inflation is burdening Japanese households.
BOJ Monetary Policy Meeting Minutes are due to be released on Tuesday and are expected to provide insight into the BOJ’s policy direction and may cause some volatility in the Yen price. Several economic activities and inflation data are scheduled to be released on Tuesday and may also affect the currency, especially the BOJ Core CPI. Yen price this week though, is expected to be affected primarily by the outcome of the much-anticipated Fed meeting on the 27th.
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