The dollar rallied on Thursday on increased political stability and hawkish Fedspeak. The dollar index was just above 106 in early trading but climbed above 107 during the day. US Treasury yields also edged higher, with the US 10-year bond touching 3.8%. Diminishing Fed rate hike expectations are putting pressure on US bond yields and dollar price, which had been trading in the overbought territory over the past few months.
US Economic activity indicators on Thursday were overall mixed. The Philly Fed Manufacturing Index fell short of expectations, printing at -19.4, against the -6.0 predicted. Negative values indicate worsening conditions in the manufacturing sector. Unemployment claims on the other hand were optimistic, dropping to 222K from 226K last week and against expectations of 228K.
The US mid-term Congressional elections last week have put pressure on the dollar. Political instability over the past week has pushed the dollar down. As markets began to digest the outcome of the elections on Thursday though, the dollar started to recover. The results of the elections were close, with the votes being tallied for a week. Republicans eventually wrested control of the House from the Democrats, winning the elections with a narrow majority. The Democratic party has lost control of the Senate and will find it hard to push its economic and political agenda in the future. Earlier this week, former US President Donald Trump announced that he would run again for President in the 2024 US elections.
Fed rhetoric is especially important this week as it may provide hints on the US central bank’s direction after recent soft inflation data. Fed rhetoric remains hawkish, although cautiously so. The consensus between FOMC members seems to be that although inflation is cooling, further tightening will be required to bring inflation down consistently to the central bank’s 2% target.
Hawkish Fed speech on Thursday provided support for the dollar. Fed’s Bullard emphasized that the Fed should err on the side of keeping rates higher for longer to avoid the mistakes of the 1970s. He also stated that, while October’s inflation data were encouraging, one month’s print is not definitive. FOMC member Loretta Mester stressed that rate hikes need a background of financial stability and that U.S. financial market weaknesses need to be addressed.
The dollar collapsed last week after US inflation data for October fell below expectations, as US Monthly CPI in October rose by 0.4% against predictions of 0.6%. Annual CPI printed at 7.7%, compared to 8.2% the previous month and the 7.9% expected.
PPI data on Tuesday confirmed that US inflation is cooling faster than expected, causing the dollar to plummet. Monthly PPI for October printed at 0.2%, against expectations of 0.4%. Monthly Core PPI, which excludes food and energy, was stagnant, versus a 0.3% rise predicted and a 0.2% rise in September.
The Fed’s recent increase in interest rates is attracting investors who seek higher returns providing support for the dollar. The US Federal Reserve voted to increase interest rates by 75 basis points at its latest monetary policy meeting. 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 of future rate hikes were considerably trimmed after last week’s inflation report and were further diminished after Tuesday’s inflation print. Slowing price pressures may induce the Fed to pivot towards a more dovish policy reducing the aggressiveness of future rate hikes. Market odds are currently between a 50-bps and a 25-bps interest rate increase in December. 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 and may cause high volatility in dollar price, such as Existing Home Sales, CB Leading Index, and Treasury Currency Report.
The Euro gained strength in early trading on Thursday, on soaring Eurozone inflation. The Euro declined later in the day though, as the dollar rallied. EUR/USD was testing the 1.036 level resistance on Wednesday. If the EUR/USD pair declines, it may find support at the parity level and further down near 0.973. If the currency pair goes up, it may encounter further resistance near 1.061.
On Thursday, the Final Eurozone headline inflation hit an all-time high of 10.6% in October. Surging inflation in the EU is mainly due to the high cost of energy. Even though Eurozone inflation reached record highs in October and was much higher than September’s print of 9.9%, it was slightly lower than the preliminary estimate of 10.7%. Lower than-expected inflation caused the Euro to retreat on Thursday, as it eases a little the pressure on the ECB to raise interest rates.
In its latest monetary policy meeting, 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. Market odds are currently in favor of a 50-bps rate hike at the ECB’s next monetary policy meeting.
Eurozone economic outlook is poor, showing signs that the EU is entering a recession, limiting the ECB’s ability to raise interest rates. Eurozone GDP grew by 0.2% in the third quarter of 2022 as expected. Economic expansion is slowing down, following a 0.7% GDP growth in the second quarter. Annual EU GDP growth was also in line with expectations, printing at 2.1%.
Analysts are predicting stagnation later this year and in the first quarter of 2023. Even though further ECB rate hikes seem certain, the magnitude of the hikes may decrease if the EU shows signs of entering a recession. Tuesday’s GDP data seem to support this scenario. Stagflation becomes a real headache for the ECB, which will be forced to battle inflation without the support of a robust economic background.
A missile landing in Poland earlier in the week threatened to bring the Russia-Ukraine war to a wider area and triggered an emergency NATO meeting on Wednesday. NATO Secretary General Jens Stoltenberg stated after the conclusion of the meeting that the deadly missile likely came from Ukraine’s air defense system. NATO’s statement helped dissipate rumors that the errant missiles were an attack against Poland by Russia and geopolitical tensions eased.
The Sterling exhibited high volatility on Thursday, especially after the announcement of the government’s fiscal statement. GBP/USD dropped to 1.176, before paring some of the day’s losses. If the GBP/USD rate goes up, it may encounter further resistance near 1.228, while support may be found near 1.133 and further down near 1.114.
The dollar’s decline last week propped up competing currencies. The Sterling, however, is under pressure from increased risk aversion sentiment. 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.
The much-anticipated fiscal plan of the new government was released on Thursday and brought volatility to the Sterling, even though the new financial statement contained few surprises. The fiscal statement was a complete reversal of the previous government’s controversial budget and aims to fill a 55-billion-pound hole in Britain's budget. Chancellor Jeremy Hunt will be cutting government spending in an attempt to restore public finances. Hunt also plans to freeze thresholds and allowances on income tax, national insurance, and pensions for a further two years.
The UK’s Chancellor announced his priorities lie with stability, growth, and public services as the government plan to tackle the cost-of-living crisis and rebuild the economy. Hunt also stated that the government will not change the BoE remit, in an attempt to restore stability in its relationship with the UK central bank.
UK inflation hit a 41-year high in October, providing support for the Sterling. Annual CPI climbed to 11.1% in October, its highest value since 1981. October’s inflation exceeded September’s print of 10.1% and expectations of 10.7%. Inflation in the UK continues to rise, mainly due to the high cost of energy. Annual core CPI, which excludes food and energy, printed at 6.5%, exceeding expectations of 6.4%. Rising UK inflation is forcing the BOE to make some tough choices against a weak economic backdrop.
The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down. UK monthly GDP for September dropped by a staggering 0.6%, against expectations of a more modest, 0.4% drop, indicating that the country is already in the grip of recession. Quarterly preliminary GDP for the third quarter of 2022 also came out negative on Friday, printing at -0.2%, compared to a 0.2% growth in the second quarter. The BOE predicts that the recession could last for almost two years, with expansion not expected again till mid-2024.
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, suggesting that future rate hikes may be softer than expected. The BOE will also be introducing another round of gilt sales this month, as they shrink their balance sheets.
Several economic activities and health indicators are scheduled to be released on Friday for the UK, including GfK Consumer Confidence and Retail Sales. These may cause volatility in Sterling's price in the wake of Thursday’s budget announcement.
The Yen retreated on Thursday, as the dollar started to recover. The USD/JPY rate increased, climbing above the 140.5 level. If the USD/JPY pair declines, support might be found at 139.4 and further down near 130.4. If the pair climbs, it may find resistance at 146.9 and further up at 151.9.
Trade balance data for Japan released on Thursday were more pessimistic than expected, putting pressure on the Yen. A negative print shows that the value of goods imported was higher than that of exports in Japan. The trade balance in October showed a deficit of 2.30T, compared to the 1.93T predicted, with the balance in favor of imported goods increasing from September’s print of -2.04T.
GDP data for Japan on Tuesday were disappointing, showing that Japan’s economy shrank in the third quarter of 2022. Preliminary GDP for Q3 of 2022 shrank by 0.3%, against expectations of growth of 0.3% and a 0.9% growth in the previous quarter. The annual Preliminary GDP Price Index printed at -0.5%, indicating that the Japanese economy is contracting, mainly due to the high costs of imported energy. Japan’s economic outlook is poor, raising recession concerns for the world’s third-biggest economy.
Lower than-expected US inflation print brought the dollar down on Tuesday, benefitting competing currencies. Cooling price pressures in the US may lead the Fed to adopt a more dovish stance, reducing the aggressiveness of future rate hikes.
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 Yen, as evidenced by the currency’s sudden surges after the USD/JPY moved above the psychological level of 150. The Japanese government cannot support the Yen indefinitely, however, as continuous interventions would not be sustainable.
The USD/JPY rate is expected to hinge largely on the dollar’s movement this week, in the wake of last week’s US inflation report. Political developments in the US are also likely to affect the dollar, as the race to control the US House continues.
The annual National Core CPI is scheduled to be released on Friday for Japan and may cause some volatility in Yen price, as inflation in Japan may affect the BOJ’s future policy direction.
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