Important calendar events
The dollar was volatile on Thursday, as political developments in the UK brought market turmoil. The dollar index plunged from above 113 to almost 112, before paring most of its losses by the end of the day. US Treasury yields soared on Thursday, with the US 10-year bond yield climbing above 4.2%, its highest level since 2008.
On the data front, the Philly Fed Manufacturing Index, which is a leading indicator of economic health, was lower than anticipated, putting pressure on the dollar. US Unemployment Claims, on the other hand, was more optimistic than anticipated, dropping to 214K from 226K last week.
The dollar’s upwards trajectory is supported by firm economic parameters though. High-risk aversion sentiment has been prevalent throughout the year and is increasing the safe-haven dollar’s appeal. At the same time, the Fed’s increase in interest rates is attracting investors who seek higher returns, boosting the dollar.
Fed rhetoric remains firmly hawkish. Fed’s Cook stressed on Thursday that inflation remains stubbornly and unacceptably high and that further rate increases would be necessary to bring inflation down. Fed’s Harker spoke along the same lines, admitting that little progress has been made in lowering inflation and hinting that the Fed may increase interest rates to well above 4% by the year’s end, then stop hiking rates sometime in 2023 and assess the impact. On Wednesday, FOMC member James Bullard pointed to an aggressive rate hike at the Fed’s November meeting, stating that the Fed should follow through with anticipated rate hikes, but he expects the aggressive hikes to end by early 2023. FOMC policymakers Esther George and Mary Daly commented over the weekend that the US Central Bank may need to step up its rate hikes to combat soaring inflation.
The US Federal Reserve recently voted to raise its interest rate by 75 basis points to curb soaring US inflation rates. The US Central Bank has increased interest rates by a total of 300 basis points this year, bringing its benchmark interest rate from 2.50% to 3.25%.
US inflation rose by 0.4% every month in September, reaching 8.2% on an annual basis, dropping only slightly from last month’s 8.3%. Even though annual inflation decreased, it exceeded expectations that it would drop to 8.1% in September. Core CPI, which excludes food and energy, rose by 0.6% in September exceeding forecasts.
Price pressures continue to increase in the US, putting extra strain on the Federal Reserve to continue its monetary tightening policy. Inflation rates have proved to be resistant to economic tightening and continue to rise. In addition, September’s data represent a period with lower fuel prices than previous months, which should have led to lower inflation rates.
The Euro exhibited high volatility on Thursday, seesawing after the political developments in the UK. The EUR/USD pair climbed to 0.985 in early trading but pared its gains later in the day. If the EUR/USD pair declines, it may find support near the 0.963 level and further down at the 0.953 level representing the 2002 low. If the currency pair goes up, it may encounter resistance at the parity level and further up at 1.019.
Eurozone inflation seems to be cooling, albeit at a glacial pace. EU Inflation in September dropped to 9.9% on an annual basis, after reaching an alarming 10% in August. Eurozone inflation fell short of expectations, which were again at double digits for September. Annual Core CPI, which excludes food and energy, was at 4.8% as expected.
Lower than-expected CPI caused the Euro to plummet on Wednesday as it eases some of the pressure on the ECB to hike interest rates. With the next ECB policy meeting next week, markets will be awaiting the Central Bank’s response. The ECB has been reluctant to raise interest rates, trying to balance soaring inflation against a poor economic outlook. Lately, however, ECB rhetoric has remained steadily hawkish, indicating decisiveness in prioritizing inflation against economic growth.
Soaring EU inflation rates and hawkish ECB rhetoric increase the odds of a 75-bp rate hike at the Bank’s next meeting in October, boosting the Euro. Eurozone inflation reached double digits in September, climbing to 10% on an annual basis, compared to 9.1% in August. Inflation in the EU is expected to rise even further in the following months driven by the high cost of energy in the Eurozone. Increased price pressures are forcing the ECB to take swift action to tackle inflation.
The Euro has been pushed down by the gap in interest rates with the US. The US Federal Reserve recently voted to raise its interest rate by 75 basis points, bringing its benchmark interest rate to 3.25%. In its latest monetary policy meeting, the ECB raised its benchmark interest rate by 75 basis points as well, but its interest rate is still only 0.75%, putting pressure on the Euro.
Europe is facing an energy crisis, driven by the EU’s dependency on Russian energy. High energy costs in the Eurozone are driving the Euro down, while inflationary pressures mount. The ongoing geopolitical crisis is putting pressure on Eurozone economies resulting in pressure on the Euro.
The Sterling seesawed on Thursday after PM Truss’ resignation. The GBP/USD rate was catapulted to 1.133 immediately after Truss’ resignation but later plummeted below 1.121. If the GBP/USD rate goes up, it may encounter resistance near 1.149 and higher up at 1.173, while support may be found near 1.092 and further down at the new all-time low of 1.035.
UK Prime Minister Liz Truss resigned from her premiership on Thursday after only six weeks, saying that she is unable to deliver on the mandate that she was elected on. Truss resigned following the chaotic scenes emerging from the House of Commons on Wednesday and Home Secretary Suella Braverman’s resignation. A Conservative party leadership election will be held next week to decide the UK’s next PM and Truss will stay on as PM until her successor has been decided.
The Sterling went up immediately after Truss’ resignation, indicating the market’s distrust in the government. After the immediate reaction died down though, the Sterling plummeted as markets digested the fact that the UK would once again be plunged into a period of political instability.
Political instability is playing a major part in the currency’s decline. Rising controversy on the mini-budget forced British Chancellor Kwasi Kwarteng to resign last week and Jeremy Hunt has been named the New Chancellor of the Exchequer. The budget included major tax cuts, which would primarily benefit the highest earners in a time of heightened economic pressure on British households. The British Government made a U-turn, revising its fiscal policy. Hunt announced on Monday that he would be reversing "almost all" the tax measures. PM Truss apologized on Monday for the new government’s economic mistakes, insisting that she has now fixed them. The apology did little to reverse the distrust towards the new government, putting pressure on the currency.
The BOE also announced a new round of bond sales on Thursday. The British central bank will hold 8 bond sales Between November 1st and the end of the year, which will be evenly distributed across the short and medium-maturity sectors only in the 4th quarter of 2022. The BOE completed a short-term bond-buying program last week, buying long-dated gilts, which have been strongly affected by repricing.
The Sterling has been declining for the past couple of weeks, as distrust towards the British government, drove the pound to an all-time low. The ailing currency was further hit on Wednesday by the release of the UK CPI data. Hotter-than-expected inflation print for September fuelled recession concerns driving the Sterling down. Annual inflation returned to 40-year highs in September, climbing to 10.1%, after cooling to 9.9% in August. The biggest jump in food prices since 1980 was largely responsible for the rising inflation. Core CPI, which excludes food and energy though, was up as well, rising to 6.5% on an annual basis in September, compared to 6.3% in August.
Rising UK inflation is forcing the BOE to make some tough choices. The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down. The Bank of England raised its interest rate by 50 bps in its latest meeting, bringing the total interest rate to 2.25%. The BOE adopted a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy.
With the BOE’s November meeting drawing near, market odds are split between a mega-hike of 100bps and a less aggressive 75bps increase. After September’s inflation report, the odds remain slightly more in favor of the larger rate hike. Even though a sharp rate hike is being priced in, the Sterling continues to move toward its recent all-time low.
The Yen reached fresh 32-year lows against the dollar on Wednesday, with USD/JPY touching the psychological barrier of 150 for the first time since August 1990. If the USD/JPY pair falls, support might be found near 143.5 and further down at 141.5. If the pair climbs, it may find further resistance higher up at the psychological level of 150 and higher still at the 1990 high near 160.
Japanese Trade balance data released on Thursday show that the trading deficit reached -2.01T for September, which was slightly lower than expected and had decreased compared to August’s -2.34T. Japan’s import costs remained high, however, mainly due to the high price of imported energy.
The USD/JPY has been trading above the 145 level for the past week. This level represented a line in the sand for the Japanese government, which had rushed to intervene when the currency pair threatened to cross this level in September and back in 1998. As the exchange rate is nearing 150, markets are bracing for an intervention.
The Japanese Ministry of Finance intervened last month in the Foreign Exchange market for the first time since 1998, buying Yen for dollars. Markets are bracing for a fresh intervention if the Yen continues to lose strength, although the government of Japan cannot support the Yen indefinitely. G7 ministers discussed the dollar’s excessive strength last week but no coordinated intervention was decided upon, leaving Japan to fend off for itself.
Japanese officials on Monday tried to stem the tide, warning that the Japanese government would offer a firm response to overly rapid Yen declines. Vice Finance Minister for International Affairs Masato Kanda said that each country would respond appropriately and firmly to excessive currency moves and Finance Minister Shunichi Suzuki stated that authorities would act decisively against excessive currency fluctuations. Suzuki also said on Wednesday that he was checking currency rates meticulously and with more frequency, alerting markets to the possibility of an intervention. As no definite plans for helping the currency were revealed though, the Japanese officials’ statements have made little impact on markets.
All eyes are going to be on the BOJ policy meeting next week, as pressure mounts on the central bank to end its negative rates policy, which is held largely to blame for the Yen’s weakness. The BOJ is unlikely to reverse its dovish policy to aid the struggling Yen, though, as BOJ Governor Kuroda is a staunch supporter of its dovish policy.
In its latest monetary policy meeting, the BOJ maintained 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. The US Federal Reserve voted to raise its interest rate by 75 basis points last week and the wide difference in interest rates is putting pressure on the Yen.
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