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Soaring Dollar pushes competing assets down

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Written by:
Myrsini Giannouli

07 July 2022
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Important calendar events

  • JPY: 30-y Bond Auction, Leading Indicators
  • EUR: German Industrial Production, Spanish and French 10-y Bond Auction, ECB Monetary Policy Meeting Accounts
  • USD: ADP Non-Farm Employment Change, Unemployment Claims, Trade Balance, FOMC Members Bullard, and Waller Speeches

USD

The dollar was catapulted to a fresh 20-year high on Wednesday, with the dollar index climbing above the 107 level. Global recession concerns are rising, propping up the safe-haven dollar, while competing assets, such as the Euro and the Sterling, are pushed down. US Bond yields also rallied on Wednesday, with the US 10-year treasury note yielding approximately 2.9%.

US Final Services PMI data which are important economic indicators were released on Wednesday. Services PMI data are indicators of business activity in the US, and the data released on Wednesday far exceeded expectations, boosting the dollar. The US Final Services PMI indicator climbed to 52.7 in June, compared to 51.6 in May. ISM Services PMI data released on Tuesday were slightly lower than last month’s, but still exceeded expectations. Positive economic data show that the economy in the US is not at imminent risk of recession, increasing the chances of a steep rate hike in July. 

FOMC Meeting Minutes were released on Wednesday and were overall hawkish, pointing to a steep rate hike in July. The Fed is determined to adopt a more aggressively hawkish fiscal policy to rein in inflation.

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. 

Concerns about the US economic downturn spurred by weak US economic data, however, are putting a lid on the dollar’s ascend. Deteriorating economic health in the US is raising recession concerns however and limits the US Federal Reserve’s ability to tighten its fiscal policy. The dollar has been supported by hawkish Fed policy but the precarious state of the US economy is putting pressure on the currency.

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. 

US Employment and Trade Balance data are scheduled to be released on Thursday and may cause some volatility in dollar prices. In addition, FOMC members Bullard and Waller are due to deliver speeches on Wednesday, which may influence the dollar, as they may provide additional insight into the Fed’s monetary policy direction. 

TRADE USD PAIRS

EUR 

The Euro’s downfall continued on Wednesday, with the EUR/USD rate trading below 1.020 for the first time in 20 years. The Euro has been pushed down this week by disappointing EU economic data and a rising dollar. If the currency pair goes up, it may encounter resistance at 1.078. If the EUR/USD continues to fall, it may find support near the 20-year low of 0.985.

The Euro has been pushed down by increased fears of a potential energy crisis in the Eurozone. EU members have recently announced a gradual ban on Russian oil imports, while Russia has retaliated by limiting its natural gas exports to certain EU countries. This week, a strike of Norwegian oil and gas workers has intensified concerns of an energy crisis in the EU.

EU economic data released on Wednesday were weak and failed to provide support for the currency. Eurozone Retail Sales data fell short of expectations, indicating that the economic health of the EU is still poor. On Wednesday’s bond auction, German 10-year Bonds yielded 1.22%, lower than last month’s 1.33%, signaling that their appeal as an investment is declining.

Indications that the Eurozone economy is slowing down are raising fears of a recession in the EU and putting pressure on the currency. 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. 

The Euro has been supported these past few weeks by expectations of an ECB shift to a more hawkish direction. As the ECB announced the end of the quantitate easing program in July however, worries about high debt levels in some Eurozone countries were revived. 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.

Several economic indicators are scheduled to be released on Thursday for the Eurozone and may affect the Euro, especially the EU Economic Forecasts. As the ECB prepares to lift its interest rate in July, such economic data are especially important as they may help determine the level of fiscal tightening that the ECB will apply.

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

The Sterling continued to retreat on Wednesday, as political uncertainty in Britain weighed on the Pound. The GBP/USD rate traded below the 1.206 level support, trading as low as 1.190. If the GBP/USD rate goes up, it may encounter resistance near the 1.240 level, while if it declines, support may be found near 1.140. 

Deteriorating economic health in the UK is keeping the currency down, while global recession fears are putting pressure on the risk-sensitive Sterling. Political woes in Britain continue unabated, reducing investor confidence in the Sterling. On Tuesday, UK Chancellor of the Exchequer Rishi Sunak and Health Secretary Sajid Javid announced their resignations from Boris Johnson’s government.

UK Construction PMI data released on Wednesday fell below expectations. Construction PMI data for June fell to 52.6, a considerable drop from 56.4 in May. These are key indicators of economic health and their decline shows that the British economy remains sluggish. 

MPC member Pill delivered a speech at the Qatar Centre for Global Banking and Finance Conference, in London on Wednesday. His speech was less hawkish than expected, putting pressure on the Sterling. The pill was in favor of a more cautious economic policy, stating that steep rate hikes are disturbing to markets and advocating for a steady-handed approach. MPC member Cunliffe on the other hand stated on Wednesday that the BOE needs to take forceful action against inflation.

The BOE Financial Stability Report released on Tuesday was bleak, with the Bank of England issuing a warning about the global economic recession. BOE Governor Andrew Bailey told a news conference following the release of the report, that lenders need to prepare for a ‘deteriorated economic outlook’.

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% on an annual basis, driven primarily by the high cost of energy imports, putting pressure on UK households.

Britain’s uncertain economic outlook, however, 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 coupled with rising inflation creates a toxic mix for the economy. 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. 

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen retreated against the dollar on Wednesday, with the USD/JPY pair climbing above 135.7. If the USD/JPY declines, support might be found near the 131.7 level and further down at 130. If the pair climbs it may find resistance at the 136.7 level and further up at the 1998 high of 147.7. 

This week, rising global recession fears have sparked a risk-aversion sentiment, boosting safe-haven assets. The dollar’s impressive rally, however, is weighing down competing currencies, such as the Yen, down. Oil prices retreated on Wednesday, providing relief for the economy of Japan, which is a net energy importer, and supporting the Yen. 

Japan’s 10-year bond yielded 0.25 at Tuesday’s bond auction, which was higher than last month’s, but remains low, fluctuating slightly above the BOJ’s 0% goal. 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 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. 

Leading economic indicators for the state of the economy in Japan are scheduled to be released on Thursday and may affect the Yen. 

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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