The dollar plummeted last week as US inflation unexpectedly cooled. The USD continued to decline in early trading on Monday, with the dollar index dropping as low as 106.5 for the first time since August. The dollar rallied a little during the day with the dollar index climbing above 107, but edged lower at the end of the day.
US Treasury yields also fell sharply last week, with the US 10-year bond yield dropping to 3.8%. On Monday, the US 10-year bond remained subdued, yielding between 3.8% and 3.9%. 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.
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. US inflation is cooling faster than expected, causing the dollar to plummet.
Fed rhetoric is especially important this week as it may provide hints on the US central bank’s direction after last week’s soft inflation data. FOMC member Chris Waller stressed on Sunday that the US central bank still has a long way to go to bring inflation down to its 2% target. He added that interest rates will continue to increase and remain high until US inflation has been brought under control. Fed’s Brainard also emphasized the need to tackle inflation but pointed to a slower pace of rate hikes down the road.
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 though. 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.
The US mid-term Congressional elections last week have put pressure on the dollar. Concerns that the Democratic party might lose control of Congress in the mid-term elections, leading to political upheaval in the US, pushed the dollar down. Over the weekend, the Democratic party announced their victory in the key State of Nevada, which would have secured control of the House for the ruling party. It seems, however, that the Democrats were too quick to rejoice, as votes are still being tallied and the battle for securing the Senate seems to be close.
Fedspeak is also of primary importance this week, as traders will pay special attention to Fed members’ speeches in an attempt to gauge any changes in the central bank’s future policy direction.
Several indicators of economic activity are scheduled to be released on Tuesday for the US and may cause high volatility in dollar prices. Most notably, US PPI data will provide an additional measure of US inflation and may affect the dollar considerably in the aftermath of last week’s CPI inflation report.
The Euro maintained last week’s gains on Monday. Cooler than-expected US inflation print caused the dollar to plummet last week, benefitting competing currencies, such as the Euro.
EUR/USD traded with low volatility on Monday, fluctuating around the 1.032 level. 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 resistance near 1.036.
Monthly Industrial Production in the Eurozone released on Monday exceeded expectations, providing support for the Euro. Industrial Production in September increased by 0.9% against expectations of a 0.1% increase, although it presented a decrease compared to August’s 2.0% growth.
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.
Record-high Eurozone inflation data indicate that the ECB’s efforts to tackle inflation have not been successful so far. Eurozone inflation in October reached 10.7% versus September’s print of 9.9%. Price pressures continue to increase in the EU, driven primarily by energy prices.
Eurozone economic outlook is poor though, showing signs that the EU is entering a recession, limiting the ECB’s ability to raise interest rates. Analysts are predicting stagnation later this year and in the first quarter of 2023. Even though further rate hikes seem certain, the magnitude of the hikes may decrease if the EU shows signs of entering a recession. Preliminary Flash GDP data seem to support this scenario. Flash GDP for the third quarter of 2022 showed economic growth of only 0.2% against an expansion of 0.8% in the previous quarter. Stagflation becomes a real headache for the ECB, which will be forced to battle inflation without the support of a robust economic background.
Several economic activities and health indicators are scheduled to be released on Tuesday and may affect the Euro. These include French Final CPI, Flash Employment Change, Quarterly Flash GDP, Trade Balance, ZEW Economic Sentiment, and German ZEW Economic Sentiment.
The Sterling was steady on Monday, holding on to last week’s gains. GBP/USD exhibited low volatility, trading around the 1.175 level. 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 a risk aversion sentiment seeping through from crypto markets over the past few days. The collapse of the FTX crypto exchange due to liquidity problems caused market turmoil last week. 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 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 last week, 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.
British economy continues to contract at an alarming pace, restricting the BOE’s ability to hike interest rates. This could potentially lead to a shift in the BOE’s priorities, from battling inflation to surviving recession. Annual inflation returned to 40-year highs in September, climbing to 10.1%, after cooling to 9.9% in August. Rising UK inflation is forcing the BOE to make some tough choices against a weak economic backdrop.
PM Sunak has vowed that economic stability will be at the heart of his administration’s agenda. The much-anticipated new fiscal plan is expected this week on Thursday and is reported to be a complete reversal of the previous government’s controversial budget. Instead of tax cuts, the current government is likely to go with tax hikes, which will be a tough sell on the British public. Chancellor Jeremy Hunt is also expected to cut government spending in an attempt to restore public finances.
Important indicators of employment are scheduled to be released on Tuesday for the UK, including The Averagee Earnings Index, Claimant Count Change, and Unemployment Rate.
The Yen edged lower on Monday, retaining however the bulk of last week’s gains. The USD/JPY rate rose marginally, climbing above the 140 level. If the USD/JPY pair declines, support might be found near 139.9 and further down at 130.4. If the pair climbs, it may find resistance at 148.9 and further up at 151.9.
Lower than-expected US inflation print brought the dollar down last week, 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.
Several economic activities and health indicators are due to be released on Tuesday for Japan and may affect the Yen's price. These include Annual Preliminary GDP Price Index, Quarterly Preliminary GDP, and Revised Industrial Production.
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