Important calendar events
The dollar was stable on Tuesday, exhibiting low volatility, with the dollar index hovering above 104. US Bond yields were also fairly stable, with the US 10-year treasury note yielding just below 3.3%.
US Existing Home Sales data released on Tuesday fell in line with expectations and no other major news was released since last week. FOMC Member Loretta Mester delivered a speech on Tuesday, which was overall hawkish, supporting the dollar. Mester warned in her speech that inflation will not fall back to the Fed’s target of 2% for the next years and that further monetary policy tightening would be required.
Last week, the US Federal Reserve voted to raise its benchmark interest rate by 75 points, taking aggressive action against inflation and bringing its interest rate to 1.75%. Record high US inflation rates have forced the Fed to ramp up its efforts by performing its steeper rate hike since 1994. With 10 out of the 11 FOMC members voting in favor of the rate hike, the Fed sent a clear signal that it plans to tackle soaring inflation rates.
Markets reacted strongly to the Fed interest rate announcement as well as the ensuing FOMC Press Conference, causing high volatility in the price of the dollar. In the days following the Fed meeting, however, the dollar has begun re-establishing its equilibrium, as markets had time to process the news.
US inflation keeps rising, forcing the Fed to tighten its monetary policy. PPI climbed 0.8% for the month and 10.8% on an annual basis, falling close to the historically high levels reached in March. CPI in May increased by 8.6% on an annual basis, the largest year-on-year increase since 1981 according to the US Labour Department. Rising costs of food and energy have contributed to soaring inflation rates in the US.
Fed Chair Powell’s testimony on the Semi-Annual Monetary Policy Report before the Senate Banking Committee on Wednesday, is expected to attract the attention of market participants who will seek to gauge the Fed’s future policy direction.
The Euro traded sideways against the dollar on Tuesday, with the EUR/USD rate fluctuating around the 1.054 level. If the currency pair goes up, it may encounter resistance at 1.078. The EUR/USD is currently testing the support at the 1.036 level that represents 2016 low and, if it falls further, it may find support near a 20-year low of 0.985.
Last week, an emergency ECB meeting raised expectations of a more hawkish monetary policy boosting the Euro. The Euro is supported this week by reports on ECB plans to raise interest rates. On Monday, ECB President Christine Lagarde confirmed plans of tightening monetary policy and raising interest rates to tackle rising inflation, propping up the Euro.
The Fed’s decisive 75 base point rate hike last week emphasized, even more, the gap between ECB and Fed policies, putting pressure on the Euro. In its latest monetary policy meeting, the ECB kept its interest rate unchanged but pointed to a small rate hike at its next meeting in July. The ECB has kept its interest rates below zero for over a decade and an increase in interest rates represents a hawkish turn in its monetary policy, to counter unprecedented inflation rates.
Even though the ECB has pointed clearly to a shift towards a more hawkish policy, stagnating Eurozone economies limit the ECB’s flexibility to increase interest rates to combat high inflation.
EU CPI inflation data show that inflation remains at record high levels of 8.1%, driven by rising food and energy costs. EU members have recently announced a gradual ban on Russian oil imports, while Russia has retaliated by limiting its natural gas exports to certain EU countries, raising fears of a potential energy crisis in the EU.
The Sterling traded sideways against the dollar on Tuesday, exhibiting low volatility, with the GBP/USD rate trading around 1.227. If the GBP/USD rate goes up, it may encounter resistance near the 1.308 level, while if it declines, support may be found near 1.200 and further down near 1.140.
MPC Members Pill and Tenreyro delivered speeches on Tuesday, which were hawkish on the whole, with BOE chief economist Huw Pill stating that further monetary policy tightening will be required in the coming months to rein in inflation.
Last week, the BOE moved towards raising its benchmark interest rate by 25 base points at its monetary policy meeting, bringing its interest rate to 1.25%. This was the fifth consecutive rate hike for the BOE, something that hasn’t been done in 25 years.
Britain’s uncertain economic outlook limits the BOE’s ability to shift towards a more aggressively hawkish policy. By performing a modest rate hike the BOE is trying to strike a balance between battling inflation and supporting the sluggish economy. The BOE’s Monetary Policy Statement last cast doubts on whether the UK Central Bank would continue its policy of monetary tightening. Even though the BOE is moving cautiously, markets are pricing in a rate hike of up to 50 base points at the bank’s next policy meeting in July, boosting the currency.
With the Fed raising its interest rate by 75 base points, the divergence in monetary policy between the Fed and the BOE becomes highlighted, putting pressure on the Sterling. In addition, the UK PM Boris Johnson has recently faced a vote of no-confidence against him, which he won by a narrow margin, with the bleak political climate reducing investor confidence in the Sterling.
Headline inflation in the UK has risen to a new 40-year high of 9%, while core inflation hit 6.2%. The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Stagflation is a risk for the UK economy, as for many other countries, as economic stagnation coupled with rising inflation creates a toxic mix for the economy.
UK Annual CPI and Core CPI data, which are leading indicators of consumer inflation, are scheduled to be released on Wednesday and may cause some volatility in the Sterling, especially after the BOE meeting last week.
MPC Member Cunliffe is due to deliver a speech on Wednesday, which may impact Sterling. The BOE is currently navigating turbulent times, and market participants will follow MPC members’ speeches closely to gauge the BOE’s direction in the coming months.
The Yen continued to decline on Tuesday sinking to a 24-year low against the dollar, with the USD/JPY pair climbing above the 135.3 level resistance representing the 2002 high of 135.3. If the USD/JPY declines, support might be found near the 130.5 level and further down at the 127 level. If the pair climbs again, it may find resistance near the 1998 high of 147.7.
This week, markets had time to absorb last week’s interest rate announcements by both the Fed and the BOJ, driving the Yen down. Last week, the BOJ defended its ultra-easy monetary policy, keeping its benchmark interest rate at -0.10%, despite the rising inflation rates in Japan. Japan’s CPI inflation index has breached the BOJ’s 2% target, reaching 2.1% for the first time in seven years.
The BOJ’s decision to keep its interest rate unchanged emphasizes the divergence between the BOJ’s fiscal policy and that of other major Central Banks, especially following the Fed’s 75 base point rate hike. While other countries are moving towards quantitative tightening, Japan continues to pour money into the economy and maintains its negative interest rate. The difference in interest rates with other major Central Banks puts the Yen at a disadvantage, driving its price down.
On Tuesday, Japanese Prime Minister Fumio Kishida stated that the BOJ should maintain its ultra-loose monetary policy, pushing the Yen further down. The BOJ and the Japanese government are in favor of a weak yen, as it makes Japanese exports more competitive and bond-buying cheaper. The combination of a weak currency and rising inflation, however, is burdening Japanese households.
The BOJ in its policy meeting last week, also kept its bond yield target at 0%. The BOJ continues to buy an unlimited amount of Japanese treasury bonds, defending their current low yield. In contrast, the respective US 10-year bond is offered with a yield of over 3%, more than an order of magnitude higher than the Japanese bond. The large divergence in bond yields makes the low-yielding Yen less appealing to investors than the dollar, pushing its price further down.
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