Important calendar events
The dollar plummeted on Tuesday, with the dollar index dropping below 109.4. US Treasury yields also declined, although not as sharply as the dollar, retaining support from last week’s Fed rate hike. The US 10-year bond yield dropped from 4.20% to 4.15% on Tuesday, while the US 2-year bond yield fell from its 15-year high of 4.74% to below 4.66%.
The dollar has been trading in overbought territory and has been slipping since last week in anticipation of Tuesday’s US elections. The USD was boosted by the Fed’s rate hike but weak jobs data pushed the dollar down last week and the dollar’s sell-off continued this week.
The US mid-term Congressional elections have been taking place on Tuesday and their outcome is as yet uncertain. 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 Tuesday’s 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 agenda.
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 interest rate increase is attracting investors seeking higher returns, boosting the dollar.
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%.
The FOMC Statement issued by the Fed contained a subtle change in forward guidance. The tone of the statement was more cautious than before, indicating that the Fed may be pondering slowing the pace of rate hikes. 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.
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%. Price pressures continue to increase in the US, putting extra strain on the Federal Reserve to continue with its policy of monetary tightening. Inflation rates have proved to be resistant to economic tightening and continue to rise.
Several indicators of economic activity are scheduled to be released on Wednesday for the US and may affect the dollar in the wake of last week’s Fed meeting. Strong USD volatility is also expected, as the mid-term election results are tallied.
The Euro soared on Tuesday, benefitting from the dollar’s decline. EUR/USD continued trading above the parity level, testing the resistance at 1.009. 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 further resistance near 1.019.
Uncertainty over the outcome of the US congressional elections has caused the dollar to plummet this week, benefitting competing currencies, such as the Euro. Eurozone retail sales data released on Tuesday were optimistic, further boosting the currency. EU retail sales in September went up by 0.4%, after remaining stagnant in August. French trade balance data for September were lower than expected though, dropping to -17.5B against expectations of -14.7B.
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.
The Sterling continued to rise on Tuesday, as the dollar declined. The pound edged lower on early trading but gained strength later in the day. GBP/USD climbed above the 1.149 level resistance, reaching 1.159. If the GBP/USD rate goes up, it may encounter resistance near 1.164, 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. The Sterling, however, 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.
The Yen gained strength on Tuesday as the dollar weakened. The USD/JPY rate continued to decline, dropping to 145.3. If the USD/JPY pair falls, support might be found near 145 and further down at 143.5. If the pair climbs, it may find resistance at 149.5, further up at 151.9, and higher still at the 1990 high near 160.
The dollar’s collapse this week has benefitted the Yen, which edged higher even in the face of disappointing economic data for Japan. Annual household spending increased by 2.3% for September, noting however a marked drop from the previous month’s 5.1%. Japanese households curbed spending in the face of higher inflation combined with a weaker economy. However, average cash earnings climbed by 2.1% in September, compared to 1.7% in August. Leading Indicators released on Tuesday were lower than expected, dropping to 97.4% in September from 101.3% in August ad against expectations of 97.9%.
The release of the BOJ Summary of Opinions on Tuesday however, 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. Several economic activities and health indicators are also due to be released on Wednesday for Japan and may affect the Yen's price. These include Bank Lending, Current Accounts, Economy Watchers Sentiment, and 30-y Bond Auctions.
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