Important calendar events
The dollar surged on Wednesday, with the dollar index rising above the 106.8 level, its highest value since November 2022. The dollar is moving in overbought territory supported by increased rate hike expectations and diminishing risk sentiment. US Treasury yields also continued gaining strength on increased future rate hike expectations, with the US 10-year bond yielding above 4.62% for the first time since 2007.
Core Durable Goods and Durable Goods orders on Wednesday exceeded expectations, boosting the dollar. Durable Goods Orders rose by 0.2% in July against a 5.6% drop in June and expectations of a 0.5% decline. Core Durable Goods Orders, which exclude transportation items, rose by 0.4% in July, the same growth they had registered in June, versus 0.2% anticipated.
Hawkish Fedspeak boosted the dollar this week. Minneapolis Fed Governor Neel Kashkari delivered a hawkish speech on Tuesday, stating that he expects interest rates to go up again this year. FOMC member Michelle Bowman also hinted at another rate hike this year.
FOMC members unanimously voted last week to keep interest rates unchanged at a target range of 5.25% to 5.50%. The Fed decided to pause rate hikes but that does not necessarily mean it has reached its rate ceiling.
The Fed policy statement following the meeting left the door open for further rate hikes. Market odds of another rate hike within the year are increasing, although it is clear that the Fed’s future policy direction will be data-driven.
Market participants focused especially on FOMC Economic Projections last week. US policymakers upgraded the US GDP outlook to 2.1% from 1.0% for 2023. Inflation was forecast to decrease further, with core PCE for 2023 expected to drop to 3.7% from previous estimates of 3.9%. The US economy is showing signs of picking up, giving the Fed more leeway to raise interest rates. At the same time, inflationary pressures are proving quite stubborn and may force the Fed to continue its hawkish policy.
Particularly illuminating was the Fed’s so-called dot plot, which illustrates the anticipated trajectory of borrowing costs as envisioned by Fed officials. The interest rate projection for 2023 stayed unchanged at 5.6%, pointing at another rate hike within the year.
US inflationary pressures are not easing just yet, despite the Fed’s high-interest rates. PPI rose by 0.7% in August, exceeding expectations of a 0.4% rise. Core PPI, which excludes food and energy, decelerated a little, rising by 0.2% in August compared to a 0.4% growth in July. Rising fuel costs are primarily to blame for the stubbornly high inflation rates in the US.
Consumer inflation is also accelerating, with CPI rising by 0.3% in August from 0.2% in July against expectations of a 0.2% print. Headline inflation came in hotter than anticipated, climbing to 3.7% year-on-year in August from 3.2% in July versus 3.6% anticipated. Core inflation, which excludes food and energy, also rose by 0.3% in August from 0.2% in July. Increasing price pressures may push the Fed to continue its hawkish policy until inflation drops closer to the Fed’s 2% target.
Preliminary GDP for the second quarter of 2023 showed that the US economy expanded by only 2.1% against expectations of 2.4% growth. The preliminary GDP price index for the 2nd quarter of the year also came in below expectations at 2.0% versus 2.2% anticipated.
GDP and GDP Price Index data on Thursday are some of the week’s most important fundamentals as they provide information on the economic outlook of the US. Several FOMC members are due to deliver speeches on Thursday. Fed Chair Powell’s speech on Thursday will be scrutinized by traders and may cause volatility in dollar prices.
EUR/USD plummeted on Wednesday as the dollar gained strength. The currency pair dropped to its lowest level since December 2022, testing the 1.050 level support. If the EUR/USD pair declines, it may find further support at 1.022, while resistance may be encountered near 1.073.
The GfK Consumer Confidence report released on Wednesday showed that Consumer Confidence declined from -25.6 in September to -26.5 in October, putting pressure on the euro.
ECB President Christine Lagarde delivered a hawkish speech on Monday, providing support for the Euro. Testifying before the Committee on Economic and Monetary Affairs in Brussels, Lagarde implied that the ECB will not raise interest rates further but reiterated that borrowing costs will remain elevated for as long as needed to bring inflationary pressures down.
Inflation in the Euro area is cooling, albeit at slow rates, according to Final CPI data released last week. Headline inflation in the Eurozone dropped slightly to 5.2% year-on-year in August from 5.3% in July. Flash CPI estimates had shown that annual CPI had remained unchanged from July at 5.3%. Core CPI, which excludes food and energy, dropped to 5.3% from 5.5% in July.
The ECB raised interest rates by 25 bp at its monetary policy meeting last week, bringing its main refinancing rate to 4.50%. The ECB had the difficult task of assessing the risk to the fragile Eurozone economy against high inflation rates. In the end, persistently high inflation induced the central bank to raise interest rates again on Thursday.
The ECB hinted that it had reached its interest rate ceiling, putting pressure on the Euro. ECB President Christine Lagarde signaled an end to rate hikes at the press conference after the conclusion of the meeting but warned that interest rates will remain at sufficiently restrictive levels for as long as necessary.
Final GDP data for the Euro area were disappointing, showing that the Eurozone economy expanded by only 0.1% in the second quarter of the year against expectations of 0.3% growth. The Eurozone economy barely expanded in the second quarter after contracting by 0.1% in Q1 of 2023. The EU economy is struggling and cannot withstand much further tightening.
GBP/USD extended losses on Wednesday, dropping to 1.214, its lowest level in six months. If the GBP/USD rate goes up, it may encounter resistance near 1.242, while support may be found near 1.210.
Last week the BOE maintained its official rate at 5.25% against expectations of a 25-bp rate hike that would bring the interest rate at 5.50%. The BOE also signaled that it had reached its peak interest rate.
BOE Governor Andrew Bailey stated last week that the central bank would be watching closely to see if further rate hikes are needed. Bailey also emphasized that the BOE will be holding interest rates in restrictive territory long enough to see inflation down to the bank’s 2% target. Bailey’s comments implied that the BOE has likely reached its rate ceiling after a long run of rate hikes.
Inflationary pressures in the UK are finally receding and likely tipped the balance in favor of a pause in rate hikes. British Inflation cooled more than expected in August, demonstrating the effectiveness of the BOE’s consistently hawkish policy. Headline inflation dropped to 6.7% year-on-year in August from 6.8% in July against expectations of 7.0%. Core CPI, which excludes food and energy, dropped significantly, indicating that rising fuel costs are largely to blame for sticky inflation in the UK. Core CPI dropped to 6.2% on an annual basis in August from 6.9% in July against 6.8% expected.
British economic growth forecasts are not optimistic with BOE predicting a weaker economic outlook. A combination of a struggling economy and high inflation is making the BOE’s task more difficult. Further tightening is needed to bring inflation down at the risk of tipping the British economy into recession.
Britain’s economy contracted by 0.5% month-on-month in July after expanding by 0.5% in June. The prognosis was more optimistic, with markets forecasting a 0.2% decline in GDP. The state of the British economy is fragile, as prolonged tightening has taken its toll on the labor market and other vital economic sectors. The British economy weakened more than expected in July, likely influencing the BOE’s decision to pause rate hikes.
USD/JPY surged on Wednesday, shooting past the 149-level resistance, and heading straight for the key 150 level. If the USD/JPY pair declines, it may find support near 147.3. If the pair climbs, it may find further resistance at 150.
The Yen has been weakening, pushed down by the BOJ’s ultra-accommodating monetary policy. The Yen’s weakness has been a subject of concern for Japanese authorities as it undermines the country’s importing potential and causes financial distress in households.
Japanese authorities have been repeatedly warning speculators against excessive short-selling of the Yen. The Yen’s continued weakness is raising market awareness of another intervention by the Japanese currency to support the ailing currency. Many market analysts view the USD/JPY 150 level as the line in the sand for another intervention. Japan’s Finance Minister Shunichi Suzuki stressed on Tuesday that no options were off the table alerting traders to the risk of another government intervention. The looming threat of government intervention is providing some support for the Yen.
The minutes of the Bank of Japan's July meeting were released on Wednesday. The minutes indicated that Japan’s policymakers are set to maintain the bank’s ultra-loose monetary settings.
At its policy meeting last week, the BOJ maintained its short-term interest rate target steady at -0.10% and showed no signs of relaxing its ultra-easy policy. Nevertheless, market odds of a BOJ rate hike in January have increased above 60%.
BOJ Governor Kazuo Ueda had hinted in the past few weeks that a policy shift may finally be on the horizon. Ueda, however, refrained from signaling any changes in policy after last week’s meeting. Ueda delivered a hawkish speech in Osaka on Monday, putting more pressure on the Yen. Ueda stressed that the wage and inflation outlook remains uncertain. Ueda added that inflation would need to remain sustainably above the BOJ’s 2% target before the central bank could consider abandoning its ultra-easy policy.
The BOJ has maintained its dovish bias, putting more pressure on the Yen as other major central banks have been moving in a hawkish direction for over a year. Even though the Fed kept interest rates steady last week, the US central bank delivered a hawkish message hinting at more rate hikes within the year. The Yen becomes even more vulnerable as other major central banks continue raising interest rates.
National Core CPI dropped to 3.1% in July from 3.3% in June. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. BOJ Core CPI climbed to 3.3% on an annual level in August beating expectations of 3.2%.
Final GDP data for the second quarter of the year showed that the Japanese economy expanded by 1.2%, disappointing expectations of 1.4% growth. The final GDP Price Index showed a 3.5% annual expansion, versus 3.4% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.
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Written by:
Myrsini Giannouli
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