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The dollar collapses as US inflation cools

Home >  Daily Market Digest >  The dollar collapses as US inflation cools

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Written by:
Myrsini Giannouli

11 November 2022
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Important calendar events

  • JPY: Core Machinery Orders, Annual PPI
  • GBP: Monthly GDP, Preliminary quarterly GDP, Construction Output, Goods Trade Balance, Index of Services, Industrial Production, Manufacturing Production, Preliminary Business Investment, NIESR GDP Estimate
  • EUR: German Final CPI, German WPI, ECOFIN Meetings
  • USD: Bank Holiday, Preliminary UoM Consumer Sentiment, Preliminary UoM Inflation Expectations, Treasury Currency Report

USD

The dollar plummeted on Thursday, with the dollar index dropping below the 108 level as US inflation unexpectedly cooled. US Treasury yields also fell sharply, with the US 10-year bond yield dropping to 3.8%.

The US mid-term Congressional elections earlier this week have put pressure on the dollar, which has been declining since last Friday, as the fate of the US Senate hangs in the balance. So far, the election results are close, but US high inflation and fuel costs have weighed the Democratic party down. Concerns that the Democratic party might lose control of Congress in the mid-term elections, leading to political instability in the US, have pushed the dollar down. If the ruling party loses control of Congress, it will not be able to push forward its political and fiscal agenda.

The Fed’s increase in interest rates, however, is attracting investors who seek higher returns boosting the dollar. Fed rhetoric this week remains hawkish, pointing to further rate hikes this year. FOMC member Williams on Wednesday emphasized the need to bring inflation under control, stating that it is currently far above the Fed's long-run goal of 2%.

The US Federal Reserve voted to increase interest rates by 75 basis points at its monetary policy meeting last week. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate in a range of 3.75% to 4.0%. Market expectations are currently in favor of a 50-bps rate hike in December and a 25-bps hike in January. Rate hikes are expected to taper off in 2023 as the central bank moves into a stable interest rate.

Several indicators of economic activity are scheduled to be released on Friday for the US, including Preliminary UoM Consumer Sentiment, Preliminary UoM Inflation Expectations, and Treasury Currency Report.

TRADE USD PAIRS

EUR 

The Euro gained strength on Thursday, benefitting from the dollar’s collapse. EUR/USD continued trading above the parity level, climbing above the 1.009 level resistance, and is currently testing the resistance at 1.019. If the EUR/USD pair declines, it may find support near the 0.973 level and further down at the 0.953 level representing the 2002 low. If the currency pair goes up, it may encounter further resistance near 1.019.

Cooler than-expected US inflation print has caused the dollar to plummet on Thursday, benefitting competing currencies, such as the Euro. Uncertainty over the outcome of the US congressional elections is also putting pressure on the dollar.

ECB rhetoric this week was especially hawkish, raising expectations of future rate hikes. Deutsche Bundesbank Joachim Nagel warned on Tuesday that the ECB needs to continue raising interest rates even if it weighs on the economy. In addition, ECB Vice President Luis De Guindos stated that further rate hikes are needed to combat inflation. 

The Euro exchange rate has been heavily influenced by the dollar’s surge in the past few months, as the US Federal Reserve continues to raise interest rates in an aggressive fight against inflation. The US Fed raised interest rates by 75 bps at its policy meeting last week, bringing its interest rate up to 4.0%. In its latest monetary policy meeting last week, the ECB raised its interest rate by 75 basis points to 1.5%, the highest since 2009. Soaring EU inflation rates are forcing the central bank to hike rates aggressively to reduce price pressures. 

The ECB however, cannot match the Fed’s aggressively hawkish pace, as Eurozone economic outlook is poor, showing signs that the EU is entering a recession. Eurozone's economic outlook is poor, with analysts predicting stagnation later this year and in the first quarter of 2023, limiting the ECB’s ability to raise interest rates. Even though further rate hikes seem certain, the magnitude of the hikes may decrease if the EU shows signs of entering a recession. Preliminary Flash GDP data seem to support this scenario. Flash GDP for the third quarter of 2022 showed economic growth of only 0.2% against an expansion of 0.8% in the previous quarter. Stagflation becomes a real headache for the ECB, which will be forced to battle inflation without the support of a robust economic background.

Record-high Eurozone inflation data indicate that the ECB’s efforts to tackle inflation have not been successful so far. Eurozone inflation in October reached 10.7% versus September’s print of 9.9%. Price pressures continue to increase in the EU, driven primarily by energy prices. 

Several economic activities and health indicators are scheduled to be released on Friday and may affect the Euro, including German Final CPI and German WPI. The ECB is forced to adjust its monetary policy on a meeting-by-meeting basis, raising interest rates as far as the Eurozone’s fragile economic outlook will allow, and will rely on economic indicators to determine the aggressiveness of its fiscal policy. In addition, ECOFIN, the Eurozone's broadest financial decision-making body is meeting on Friday and the outcome of the meeting may cause volatility in Euro price.

EURUSD 1hr chart

TRADE EUR PAIRS

GBP 

The Sterling gained strength on Thursday, benefitting from the dollar’s collapse. GBP/USD rose past the 1.149 level resistance and the 1.164 level resistance. If the GBP/USD rate goes up, it may encounter further resistance near 1.228, while support may be found near 1.125 and further down at the new all-time low of 1.035. 

The dollar’s decline this week has propped up competing currencies. Uncertainty over the results of the US mid-term elections has caused the dollar to retreat sharply and unexpectedly low US inflation data have pushed the dollar further down on Friday. 

The Sterling, however, is under pressure from a risk aversion sentiment seeping through from crypto markets over the past few days. The collapse of the FTX crypto exchange due to liquidity problems has caused market turmoil this week. The pound is also threatened by political uncertainty in the UK. Political instability has been playing a major part in the currency’s decline over the past few months, driving the pound to an all-time low. 

PM Sunak has vowed that economic stability will be at the heart of his administration’s agenda. Foreign minister James Cleverly has indicated that the much-anticipated new fiscal plan is expected on November 17th and is reported to be a complete reversal of the previous government’s controversial budget. Instead of tax cuts, the current government is likely to go with tax hikes, which will be a tough sell on the British public. 

BOE members voted to increase interest rates by 75 bps last week, matching the Fed’s rate hike. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate up to 4.0%. Currently, the BOE’s interest rate is at 3.0% and the difference with the Fed’s rate is putting pressure on the Sterling. 

In addition, the BOE did not offer specific forward guidance last week, suggesting that future rate hikes may be softer than expected. BOE Governor Andrew Bailey warned that the country is already in recession, which could point to a shift in the BOE’s priorities, from battling inflation to surviving recession. The BOE predicts that the recession could last for almost two years, with expansion not expected again till mid-2024.

The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down. Annual inflation returned to 40-year highs in September, climbing to 10.1%, after cooling to 9.9% in August. Rising UK inflation is forcing the BOE to make some tough choices. 

Important economic activity indicators are scheduled to be released on Friday and primarily Monthly GDP and Preliminary quarterly GDP. The UK is in the grip of recession fears and the future financial outlook of the BOE is expected to depend heavily on the country’s GDP in the coming months.

GBPUSD 1hr chart

TRADE GBP PAIRS

JPY

The Yen gained strength on Thursday, as the dollar collapsed. The USD/JPY rate plummeted, falling below the 145 level support, and reaching the 141 level. If the USD/JPY pair falls, support might be found near 139.9. If the pair climbs, it may find resistance at 148.4, further up at 149.5, and higher still at the 1990 high near 160.

Lower than-expected US inflation print on Thursday brought the dollar down, benefitting competing currencies. Cooling price pressures in the US may induce the Fed to pivot towards a more dovish direction, reducing the aggressiveness of rate hikes. In addition, the votes for the US mid-term elections are still being tallied, promoting a climate of political uncertainty and putting pressure on the dollar.

The release of the BOJ Summary of Opinions on Tuesday also bolstered the Yen. The report is based on the latest BOJ policy meeting ad was more hawkish than expected. BOJ members reaffirmed their commitment to the bank’s ultra-easy policy for the time being. Rising inflation in Japan, however, led to a debate on a future exit from the central bank’s dovish policy. The BOJ revised core CPI projections for 2022 to 2.9% from 2.3% previously, as recent inflation data in Japan exceeded expectations. 

In its latest policy meeting, the BOJ left its monetary policy unchanged, as expected. 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, especially with the Fed, puts the Yen at a disadvantage, driving its price down. 

Japanese authorities recently staged interventions to support the collapsing Yen, as evidenced by the currency’s sudden surges. The USD/JPY had moved well above the psychological level of 150 when it plummeted suddenly in what was undoubtedly large-scale selling of dollars and buying Yen. The suspected interventions failed to stem the tide, however, and the Yen continued to retreat. The Japanese government cannot support the Yen indefinitely, as continuous interventions would not be sustainable. 

The USD/JPY rate is expected to hinge largely on the dollar’s movement this week, although market participants remain wary of further surprise interventions from the government of Japan. The outcome of the US mid-term elections is expected to affect the USD/JPY rate on Thursday as also the release of the highly-anticipated US inflation data.

The USD/JPY rate is expected to hinge largely on the dollar’s movement this week, although market participants remain wary of further surprise interventions from the government of Japan. Several economic activities and health indicators are also due to be released on Friday for Japan and may affect the Yen's price. These include Core Machinery Orders and Annual PPI.

USDJPY 1hr chart

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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