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Risk appetite returns, driving the dollar down

Home >  Daily Market Digest >  Risk appetite returns, driving the dollar down


Written by:
Myrsini Giannouli

18 May 2022
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Important calendar events

  • JPY: Annual Preliminary GDP Price Index, Quarterly Preliminary GDP, Revised Industrial Production
  • GBP: Annual CPI and Core CPI, Monthly PPI Input and Output, Annual RPI, Annual HPI
  • EUR: ECB Financial Stability Review, Annual Final CPI and Core CPI, German 30-year Bond Auction


The dollar reached a 20-year high last week, with the dollar index climbing to 104.97. The US dollar has been rising, surpassing its pandemic high of 2020, supported by hawkish Fed monetary policy and strong inflationary pressures. US yields also remained high last week, with the US 10-year treasury note yielding above 3%. 

The dollar pared some of its gains this week, with the dollar index falling to 103.3 on Tuesday. The USD, which has been moving into overbought territory, softened this week. US yields also withdrew on Monday but climbed back up on Tuesday with the US 10-year treasury note yielding above 3%. 

On Tuesday, Core Retail Sales and Retail Sales data showed that consumer spending is increasing despite the high inflation rates, indicating that economic activity is not stalling in the US as feared. 

Fed Chair Jerome Powell stated on Tuesday that the Fed would keep raising interest rates until inflation comes down. In addition, Fed member John Williams stated on Monday that tackling high inflation rates should be the Fed’s top priority. Even though Fed rhetoric continues to be hawkish though, the USD is on the decline as risk-appetite returns to markets and investors turn away from safe-haven markets.

PPI data released for the US last week showed that wholesale inflation rose by 0.5% last month and by 11% year to year in April. Producer prices keep rising, indicating that inflation rates are accelerating in the US. US CPI data also exceeded expectations, showing that US inflation is not slowing down as much as forecasted, with consumer prices rising at an annual pace of 8.3% in March. Inflation rates in the US are expected to rise even further, as April’s inflation rates are going to reflect the recent rise in energy prices. 

The dollar has been boosted by hawkish Fed policy and increased risk-aversion sentiment. Continued Russian hostilities against Ukraine have increased risk-aversion sentiment these past two months, providing support for the safe-haven dollar. As there is still no end in sight to the crisis, the dollar’s appeal as an investment remains high. 

In its latest monetary policy meeting, the US Federal Reserve raised its benchmark interest rate by 50 base points to 1%. This is the first time that the Fed has performed such a steep rate hike since 2000. The Fed has also announced that it would move towards a policy of gradual quantitative tightening. The Fed’s balance sheet has risen to approximately 9 trillion USD during the pandemic and the US Central Bank has decided to start trimming its balance sheet.



The Euro regained some of its lost ground against the dollar on Tuesday and the EUR/USD was catapulted to the 1.055 level. If the currency pair goes up, it may encounter resistance at 1.093 and further up at 1.118. If the currency pair falls, it may encounter support at the 1.036 level which represents 2016 low and further down near a 20-year low of 0.985.

Increased risk-aversion sentiment and hawkish Fed policy have boosted the dollar at the expense of other currencies, with the Euro suffering heavy losses these past few weeks. This week, however, risk appetite seems to grow once more as China emerges from lockdown and the global economic outlook seems less bleak.

On Tuesday, higher than expected Flash GDP data raised hopes that the Eurozone economy is moving in a positive direction. EU economic forecasts released on Monday showed that Eurozone inflation forecasts were increased to 6.1% in 2022, while growth projections were lowered. Even though economic conditions in the EU are not improving as much as expected, high inflation rates support the Euro, as they increase the chances of an ECB rate hike later in the year. 

Clear indications from the ECB that it would move towards a more hawkish policy this year, also boosted the Euro this week. Markets are now pricing in up to 100 base points rate hikes throughout the year. 

On Tuesday, ECB President Christine Lagarde delivered a speech at a charity event in Germany, emphasizing the role of national central bank chiefs. ECB Member Francois Villeroy stated on Monday that he is in favour of a decisive June meeting and that an active summer should be expected in terms of the ECB’s monetary policy, further raising expectations of a shift towards a more hawkish policy.

Many of the ECB’s members are in favour of taking aggressive steps towards monetary policy normalisation. ECB President Christine Lagarde is in favour of a more dovish stance but has recently shown signs of wavering, stating that the ECB will likely end its bond-buying programme in the third quarter of 2022 and a rate hike might follow just a few weeks later. 

ECB members are starting to agree on a more hawkish policy starting in the third quarter of the year and the consensus between them seems to be that the ECB will perform its first rate hike in decades at its next policy meeting in July. The US Federal Reserve has raised its benchmark interest rate by 50 base points to 1%, highlighting the difference in monetary policy between the EU and the US and has been driving the Euro down. 

Several economic indicators are scheduled to be released on Wednesday for the Euro, the most important of which is the annual Final CPI and Core CPI indicators. The CPI data are key indicators of consumer inflation and may have a strong impact on the Euro as they can influence the ECB’s decision to raise its interest rates. Headline inflation in the Eurozone is expected to remain close to 7.5%, although there is a possibility that inflation figures will be higher than forecasted.

EURUSD 1hr chart



The sterling has been under pressure for the past few weeks, falling against the dollar. On Tuesday however, the dollar weakened and the sterling gained strength, catapulting the GBP/USD to the 1.25 level. If the GBP/USD rate goes up, it may encounter resistance at the 1.263 level and further up near the 1.331 level, while if it declines, support may be found near the two-year low at 1.206. 

Increasing risk appetite this week has pushed the dollar down from its 20-year highs, while riskier assets were boosted. On Tuesday, the sterling gained support from strong economic data in the UK. The UK jobs sector seems to be recovering from the effects of the pandemic, as employment data on Tuesday indicate that the unemployment rate is going down, hitting its lowest level in nearly 50 years.

UK Monetary Policy Report Hearings took place on Monday, at which the BOE Governor and several MPC members testified on inflation and the economic outlook before the Parliament's Treasury Committee. BOE Governor Andrew Bailey admitted that the Bank is facing its biggest inflationary test in 25 years and defended the BOE’s policy regarding soaring inflation rates in the UK.

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 contrast, the increasingly hawkish Fed policy is boosting the dollar against the pound.

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 BOE stressed once more the dangers of recession, as the economic contraction is battling with inflation rates that are predicted to surge to 40-year highs of 10% in the coming months. 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.

Brexit issues have come once again into the foreground after elections to the Northern Ireland Assembly. Last week, the EU rejected the latest UK proposal regarding the Northern Ireland protocol and the situation could trigger Article 16 of the Brexit deal, adding pressure to the pound. 

Several economic data are scheduled to be released on Wednesday for the sterling, including Annual CPI and Core CPI, Monthly PPI Input and Output, Annual RPI, and Annual HPI. The release of the Annual CPI data is eagerly awaited by market participants, as these are key indicators of consumer inflation. With inflation rates reaching record highs in the UK, inflation data may affect the BOE’s policy. Markets typically react to news of high inflation in favour of the currency, as high inflation rates should increase the probability of the BOE moving towards a more hawkish direction. Current economic conditions however are fragile, and soaring inflation rates add more pressure to struggling British households, which could lead the BOE to move towards alleviating the cost of living in the UK.

GBPUSD 1hr chart



The USD/JPY rate climbed back up on Tuesday, even as the dollar retreated. The currency pair traded mostly sideways on Tuesday, increasing slightly to 129.7. If USD/JPY continues to rise, it may find resistance at 131.35 and further up at the 2002 high of 135.3. If the USD/JPY declines, support might be found near the 121.3 level and further down near the 118 level. 

The dollar softened on Tuesday, as risk-aversion sentiment started to wan. The Yen dropped even more though, as investors moved away from safe-haven assets.

On Monday, the annual PPI in Japan rose to 10% for April and was higher than expected, indicating that inflation rates are rising in Japan, mostly due to the rising costs of imported energy.

The Yen has been retreating for months, with market investor interest in the currency slowing down, despite global economic risks. The currency, which has been oversold, regained some of its lost ground at the end of last week, but the outlook for the USD/JPY pair remains bullish.

Bond yields fell across Japan’s treasury curve last week, giving weak results, due to low demand. Japan’s 10-year government bond yield auction last week maintained the 0.25% interest rate as 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 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.

Important economic data scheduled to be released on Wednesday for the Yen include the Annual Preliminary GDP Price Index and Quarterly Preliminary GDP and may affect the currency.

USDJPY 1hr chart


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Written by:
Myrsini Giannouli

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