Important calendar events
The dollar had a bullish run on Wednesday, gaining strength against a basket of other currencies. The dollar index gained more than a full point, rising from below 112 to above 113 within the day. US Treasury yields also soared, with the US 10-year bond yield climbing from 4.0% to above 4.1%.
The dollar had slipped at the beginning of the week, trading with low volatility, as many market participants awaited the results of the UK and EU inflation reports. Both the Sterling and the Euro declined concerning the dollar after the release of the inflation data, boosting the dollar. Minor economic indicators released on Wednesday were optimistic for the US economic outlook.
The dollar’s upwards trajectory is also supported by firm economic parameters. 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 increase in interest rates is attracting investors who seek higher returns, boosting the dollar.
Fed rhetoric remains firmly hawkish, with FOMC policymakers Esther George and Mary Daly commenting over the weekend that the US Central Bank may need to step up its rate hikes to combat soaring inflation.
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%. Even though annual inflation decreased, it exceeded expectations that it would drop to 8.1% in September. Core CPI, which excludes food and energy, rose by 0.6% in September exceeding forecasts.
Price pressures continue to increase in the US, putting extra strain on the Federal Reserve to continue its monetary tightening policy. Inflation rates have proved to be resistant to economic tightening and continue to rise. In addition, September’s data represent a period with lower fuel prices than previous months, which should have led to lower inflation rates.
So far, US inflation does not show signs of cooling at the expected rate, despite the Fed’s efforts. Sharp rate hikes and continuous fiscal tightening run the risk of tipping some of the world’s leading economies into recession.
The US Federal Reserve recently voted to raise its interest rate by 75 basis points to curb soaring US inflation rates. The US Central Bank has increased interest rates by a total of 300 basis points this year, bringing its benchmark interest rate from 2.50% to 3.25%.
Macroeconomic data scheduled to be released on Thursday for the US include the Philly Fed Manufacturing Index, which is a leading indicator of economic health, and the US Unemployment Claims. The release of this data may have some impact on impact on the dollar especially given the low market volatility exhibited earlier in the week. Several FOMC members are due to deliver speeches on Thursday and these may also affect the dollar, which is driven largely by Fed rhetoric.
The Euro lost ground against the dollar on Wednesday, with the EUR/USD pair plummeting from 0.987 in early trading to 0.975 later in the day. If the EUR/USD pair declines, it may find support near the 0.953 level and further down at the 0.845 level representing the 2002 low. If the currency pair goes up, it may encounter resistance at the parity level and further up at 1.019.
Eurozone inflation seems to be cooling, albeit at a glacial pace. EU Inflation in September dropped to 9.9% on an annual basis, after reaching an alarming 10% in August. Eurozone inflation fell short of expectations, which were again at double digits for September. Annual Core CPI, which excludes food and energy, was at 4.8% as expected.
Lower than-expected CPI caused the Euro to plummet on Wednesday as it eases some of the pressure on the ECB to hike interest rates. With the next ECB policy meeting next week, markets will be awaiting the Central Bank’s response. The ECB has been reluctant to raise interest rates, trying to balance soaring inflation against a poor economic outlook. Lately, however, ECB rhetoric has remained steadily hawkish, indicating decisiveness in prioritizing inflation against economic growth.
Soaring EU inflation rates and hawkish ECB rhetoric increase the odds of a 75-bp rate hike at the Bank’s next meeting in October, boosting the Euro. Eurozone inflation reached double digits in September, climbing to 10% on an annual basis, compared to 9.1% in August. Inflation in the EU is expected to rise even further in the following months driven by the high cost of energy in the Eurozone. Increased price pressures are forcing the ECB to take swift action to tackle inflation.
The Euro has been pushed down by the gap in interest rates with the US. The US Federal Reserve recently voted to raise its interest rate by 75 basis points, bringing its benchmark interest rate to 3.25%. In its latest monetary policy meeting, the ECB raised its benchmark interest rate by 75 basis points as well, but its interest rate is still only 0.75%, putting pressure on the Euro.
Europe is facing an energy crisis, driven by the EU’s dependency on Russian energy. High energy costs in the Eurozone are driving the Euro down, while inflationary pressures mount. The ongoing geopolitical crisis is putting pressure on Eurozone economies resulting in pressure on the Euro.
On the data front, only minor indicators are due on Thursday, which is not likely to affect the Euro considerably.
The Sterling collapsed on Wednesday after the release of the UK inflation data. The GBP/USD rate exhibited high volatility, falling from 1.135 in early trading to below 1.120 later in the day. If the GBP/USD rate goes up, it may encounter resistance near 1.149 and higher up at 1.173, while support may be found near 1.092 and further down at the new all-time low of 1.035.
The Sterling had been declining for the past couple of weeks, as the announcement of the first ‘mini-budget’ brought the market’s distrust of the new British government, driving the pound to an all-time low. The ailing currency was further hit on Wednesday by the release of the UK CPI data. Hotter-than-expected inflation print for September fuelled recession concerns driving the Sterling down. Annual inflation returned to 40-year highs in September, climbing to 10.1%, after cooling to 9.9% in August. The biggest jump in food prices since 1980 was largely responsible for the rising inflation. Core CPI, which excludes food and energy though, was up as well, rising to 6.5% on an annual basis in September, compared to 6.3% in August.
Rising UK inflation is forcing the BOE to make some tough choices. The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down. The Bank of England raised its interest rate by 50 bps in its latest meeting, bringing the total interest rate to 2.25%. The BOE adopted a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy.
With the BOE’s November meeting drawing near, market odds are split between a mega-hike of 100bps and a less aggressive 75bps increase. After September’s inflation report, the odds remain slightly more in favor of the larger rate hike. Even though a sharp rate hike is being priced in, the Sterling continues to move toward its recent all-time low.
Political instability is playing a major part in the currency’s decline. Rising controversy on the mini-budget forced British Chancellor Kwasi Kwarteng to resign last week and Jeremy Hunt has been named the New Chancellor of the Exchequer. The budget included major tax cuts, which would primarily benefit the highest earners in a time of heightened economic pressure on British households. The British Government made a U-turn, revising its fiscal policy. Hunt announced on Monday that he would be reversing "almost all" the tax measures. PM Truss apologized on Monday for the new government’s economic mistakes, insisting that she has now fixed them. The apology did little to reverse the distrust towards the new government, putting pressure on the currency.
The BOE had to resort to a new bond-buying program, to restore order to markets last week. The BOE aimed to stem the sell-off in the UK gilt market by buying long-dated gilts, which have been strongly affected by repricing.
The Yen reached fresh 32-year lows against the dollar on Wednesday, with USD/JPY trading well above the 147.7 level representing 1998 high. The currency pair touched the 149.9 level on Wednesday, moving perilously close to the psychological barrier of 150. If the USD/JPY pair falls, support might be found near 143.5 and further down at 141.5. If the pair climbs, it may find further resistance higher up at the psychological level of 150 and higher still at the 1990 high near 160.
The USD/JPY has been trading above the 145 level for the past week. This level represented a line in the sand for the Japanese government, which had rushed to intervene when the currency pair threatened to cross this level in September and back in 1998. As the exchange rate is nearing 150, markets are bracing for an intervention.
The Japanese Ministry of Finance intervened last month in the Foreign Exchange market for the first time since 1998, buying Yen for dollars. Markets are bracing for a fresh intervention if the Yen continues to lose strength, although the government of Japan cannot support the Yen indefinitely. G7 ministers discussed the dollar’s excessive strength last week but no coordinated intervention was decided upon, leaving Japan to fend off for itself.
Japanese officials on Monday tried to stem the tide, warning that the Japanese government would offer a firm response to overly rapid Yen declines. Vice Finance Minister for International Affairs Masato Kanda said that each country would respond appropriately and firmly to excessive currency moves and Finance Minister Shunichi Suzuki stated that authorities would act decisively against excessive currency fluctuations. Suzuki also said on Wednesday that he was checking currency rates meticulously and with more frequency, alerting markets to the possibility of an intervention. As no definite plans for helping the currency were revealed though, the Japanese officials’ statements have made little impact on markets.
On the other hand, the BOJ is unlikely to reverse its dovish policy to aid the struggling Yen. In its latest monetary policy meeting, 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 puts the Yen at a disadvantage, driving its price down. The US Federal Reserve voted to raise its interest rate by 75 basis points last week and the wide difference in interest rates is putting pressure on the Yen.
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