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The dollar soars as US inflation rises

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Written by:
Myrsini Giannouli

14 September 2022
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Important calendar events

  • JPY: Core Machinery Orders, Revised Industrial Production
  • GBP: CPI and Core CPI, PPI Input and Output, RPI, HPI
  • USD: PPI and Core PPI

USD

The dollar spiked on Tuesday after the release of higher-than-expected US inflation data and the dollar index rose above 109.6. US Treasury yields also rose, with the US 10-year bond yielding above 3.4%. 

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.

The dollar went up after the release of the US inflation data, 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.

Inflation PPI data are due on Wednesday and may affect the dollar significantly, especially after the release of the CPI indicators, as US inflation levels are expected to play a crucial role in deciding this month’s Fed rate hike. 

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EUR 

The Euro plummeted on Tuesday, on weak Eurozone economic data. At the same time, the dollar soared on higher-than-expected US inflation data and the EUR/USD rate fell back to the parity level. 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. 

On Tuesday, the German ZEW Economic Sentiment Index decreased to -61.9 from -55.3 in August, while Eurozone ZEW Economic Sentiment fell to 60.70 in September from -54.90 in August. EU economic outlook remains poor, limiting the ECB’s ability to hike interest rates and putting pressure on 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. On Monday, hawkish ECB rhetoric propped up the Euro. Bundesbank President Joachim Nagel stated over the weekend that further steps are required to bring Eurozone inflation under control, 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. 

EURUSD 1hr chart

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GBP 

The Sterling dipped again on Tuesday, after touching its lowest level since 1984 last week. The GBP/USD plummeted to the 1.151 level after the release of the US 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 Tuesday, higher-than-expected US inflation data boosted the dollar at the expense of competing currencies.   

UK Unemployment Rate dropped to 3.6% on Tuesday compared to last month’s 3.8%. Britain's jobless rate hit its lowest since 1974 providing some support for the Sterling. At the same time, wages in the UK, as estimated by the Average Earnings Index, rose 5.5% compared to the previous print of 5.2%.

UK monthly GDP data released on Monday fell below expectations, putting pressure on the Sterling. Britain’s GDP grew by 0.2% in July, against expectations of a 0.3% growth. This was higher than the previous month’s data, however, which had shown a contraction in GDP. 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. 

Inflation CPI and PPI data due on Wednesday may have a considerable impact on the currency ahead of the next BOE monetary policy meeting next week.

GBPUSD 1hr chart

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JPY

The Yen plummeted against the dollar on Tuesday, dropping near to last week’s 24-year low. The USD/JPY spiked up, climbing above 144.5. 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 Tuesday, high US inflation data increased the odds of a steep Fed rate hike this month.

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 Wednesday for Japan, which may affect the Yen slightly. 

USDJPY 1hr chart

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Written by:
Myrsini Giannouli

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