Important calendar events
The dollar withdrew slightly on Wednesday, as the release of US PPI data came close to expectations and the dollar index fell below 109.5. US Treasury yields remained strong, with the US 10-year bond yielding above 3.4%.
US PPI data were in line with expectations, with monthly PPI dropping by 0.1%, compared to last month’s drop of 0.5%, and Core PPI climbing by 0.4%, compared to last month’s 0.2%.
US CPI data released on Tuesday exceeded expectations, propelling the dollar upwards. US inflation forecasts indicated that headline inflation was going to decline, due to decreased fuel costs. Monthly CPI was projected to decrease by 0.1%. Instead, CPI increased by 0.1% in August. Annual CPI through August increased by 8.3%, which presents an improvement compared to July’s 8.5% and June’s peak of 9.1%. US inflation, however, was expected to decelerate at a faster pace this month due to a slowdown in energy costs. The monthly core CPI in August increased by 0.6% against the 0.3% forecasted.
US inflation data are propping up the dollar, as the Fed is likely to maintain a hawkish stance this month to combat persistently high inflation rates.
Fed rhetoric propelled the dollar to 20-year highs in the past couple of weeks amidst mounting expectations of a steep Fed rate hike in September. Markets are currently wavering between a 50-bp and a 75-bp Fed rate hike in September, with odds favoring a 75-bp rate hike after Tuesday’s inflation data.
Several economic activity indicators are scheduled to be released on Thursday for the US, including Core Retail and Retail Sales, Empire State Manufacturing Index, Philly Fed Manufacturing Index, and Unemployment Claims.
The Euro struggled to maintain parity with the dollar on Wednesday, even as the dollar weakened. Currently, the currency rate is testing support at the strong psychological parity level of 1.000. If the EUR/USD declines further, it may find support at the 0.845 level representing the 2002 low. If the currency pair goes up, it may encounter resistance at 1.019 and further up at 1.036.
High US inflation rates are likely to force the Fed to perform another steep rate hike this month. Even though the ECB has also raised its interest rates, the Fed will probably continue moving at an aggressively hawkish pace. As the difference in interest rates between the Fed and the ECB remains high, the dollar gains ground against the Euro.
In an unprecedented move last week, the ECB raised its benchmark interest rate by 75 basis points, hiking its deposit rate to 0.75% from zero. The ECB will start paying interest on government deposits in a bid to keep that cash from flooding an already replete market facing a squeeze in bonds. Markets are now poised for the ECB’s next move. Hawkish ECB rhetoric has propped up the Euro, with ECB officials pointing at further rate hikes this year.
Europe however, is facing an energy crisis, which seems to be escalating, driven by the EU’s dependency on Russian energy. High energy costs in the Eurozone are driving the Euro down, while inflationary pressures mount.
Eurozone headline CPI jumped to 9.1% on an annual basis in August, the highest on record. Inflation in the EU is expected to rise even further in the following months, possibly reaching double digits, driven by the high cost of energy in the Eurozone. Increased price pressures are forcing the ECB to take swift action to tackle inflation. Rising Eurozone inflation is expected to figure largely in determining the future ECB monetary policy.
The Sterling rose on Wednesday, as UK inflation unexpectedly cooled. The GBP/USD edged higher, rising to the 1.158 level after the release of the UK inflation data. If the GBP/USD rate goes up, it may encounter resistance near the 1.190 level, while if it declines, support may be found near 1.140, representing the 2020 low.
The Sterling has been under pressure by the ascend of the dollar for the past few weeks. On Wednesday, the dollar dipped and the Sterling regained some strength. Annual inflation in August cooled unexpectedly, dropping to 9.9% from 10.1% in July. UK CPI was lower than expected in August, with forecasts again at double digits. The Sterling has been hit hard this year by soaring UK inflation rates, and the cooling inflation data boosted the currency on Wednesday.
UK monthly GDP data fell below expectations, putting pressure on the Sterling. Britain’s GDP grew by 0.2% in July, against expectations of a 0.3% growth. The BOE has warned that recession is expected to hit the UK in the fourth quarter of this year, and is forecasted to last for five quarters, until the end of 2024, with GDP falling to 2.1%.
Last week marked historic changes for Britain, seeing a new monarch and Prime Minister within a few days. The Sterling dropped after Queen Elizabeth’s death on Thursday but did not exhibit high volatility, as the Queen’s health had been deteriorating for some time.
A climate of political uncertainty has been putting pressure on the GBP over the past few months, especially after former PM Boris Johnson’s resignation in July. On Tuesday, Former Foreign Secretary Liz Truss formally became UK’s next Prime Minister, bringing a measure of stability and propping up the Sterling.
Truss’ appointment provoked mixed reactions to markets, as she had questioned the BOE’s mandate in the past and her future stance towards the BOE may undermine the Sterling. Truss, however, announced an ambitious plan to prop up energy in the UK and reduce the average cost of energy for households, by funneling billions to the sector.
The much-anticipated BOE monetary policy meeting, which had been scheduled for the 15th, has been postponed to the 22nd following the death of Queen Elizabeth. In its latest monetary policy meeting, the Bank of England raised its interest rate by 50 bps, bringing the total interest rate up to 1.75%. The BOE has adopted a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. Markets are pricing in a rate hike of at least 50 bp at the next BOE policy meeting in September.
Britain’s poor economic outlook is preventing a more hawkish fiscal policy and is hampering the BOE’s attempts to bring inflation down. UK inflation reached double digits in July, with CPI climbing to 10.1% on an annual basis and is expected to rise even higher in the following months. Soaring energy and food prices put pressure on British households.
The Yen pared some of the week’s losses on Wednesday, after dropping near a 24-year low on Tuesday and the USD/JPY withdrew to the 143 level. If the USD/JPY pair falls, support might be found near 138.0 and further down at 134.2. If the pair climbs, it may find further resistance at the 1998 high of 147.7.
The increased divergence between the US and Japanese monetary policies has widened the gap between their respective bonds, putting pressure on the Yen. The BOJ keeps bond yields low, weakening the Yen.
On Wednesday, reports that the Bank of Japan is conducting a rate check in preparation for currency intervention, boosted the Yen. The Yen’s extreme weakness seems to have finally caught the attention of Japanese officials. BOJ Governor Haruhiko Kuroda has stated that sudden moves in the currency increase uncertainty and are undesirable. Seiji Kihara, the deputy chief cabinet secretary of the Japanese government, stated recently that Japan's government must take steps as needed to counter excessive declines in the Yen. Increasing comments by Japanese officials expressing concern about the Yen’s weakness may hint at a hawkish shift in the BOJ’s monetary policy.
The BOJ maintains its ultra-easy monetary policy, keeping its main refinancing rate at -0.10%. Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down.
Inflationary pressures are increasing in Japan, mainly due to the high cost of imported energy. The combination of a weak currency, low wages, and rising inflation is burdening Japanese households.
Minor economic indicators are scheduled to be released on Thursday for Japan, which may affect the Yen slightly.
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