Important calendar events
The dollar rallied on Thursday after the release of the US PCE data, with the dollar index rising to 104.2. US treasury yields edged lower, with the US 10-year bond yielding approximately 4.25%.
The dollar is likely to be influenced by US fundamentals this week. Core PCE Price Index data released on Thursday were in line with expectations. Core PCE, which is the Fed’s preferred inflation gauge, rose by 0.4% in January compared to December’s 0.2% growth. On an annual basis, Core PCE was at 2.8% in January, down from 2.9% in December. Core PCE Price Index data showed that US disinflation is progressing, albeit slowly. Jobless claims, also released on Thursday, were up to 215K from 202K the week before against expectations of 209K.
Preliminary US GDP data on Wednesday were underwhelming, putting pressure on the dollar. The US economy remains robust and expanded by 3.2% in the final quarter of 2023, missing, however, market forecasts of 3.3%.
US Durable Goods Orders declined by 6.1% in January according to data released on Tuesday, against a 0.3% drop in December and expectations of a 4.9% drop. Core Durable Goods Orders, which exclude transportation items, were also disappointing, contracting by 0.3% in January, compared to 0.5% growth in December and expectations of 0.2% growth.
The US Federal Reserve kept interest rates unchanged at its meeting in January, within a target range of 5.25% to 5.50%. The Fed has removed the tightening bias from its policy statement, indicating that the central bank is preparing to pivot to a less restrictive monetary policy. Fed Chair Jerome Powell, however, has discounted the possibility of a rate cut in March.
Fed officials wish to see more evidence of disinflation before moving ahead with cutting interest rates. Several Fed officials maintained a hawkish stance last week, indicating that they are not ready to start reducing interest rates.
FOMC members’ opinions are starting to diverge, however, and we may see a battle of doves against hawks at the next policy meeting. For the first time, policymakers are discussing openly the possibility of rate cuts sometime this year. Even though most FOMC members agree that they are not yet ready to start reducing interest rates, markets are interpreting the change in rhetoric as a sign that the Fed is considering a pivot to a more dovish policy.
Rate cut expectations have been fluctuating strongly in the past couple of weeks. Odds of a rate cut in March are practically nil. Rate cut odds in May are also down to 20% from over 80% a few weeks ago. In addition, only 25 basis points of rate cuts are priced in by May, against 25-50bp before. Market expectations of rate cuts are becoming more moderate as policymakers have stated that they intend to start reducing interest rates slowly.
US inflation surprised on the upside last week boosting the dollar. US Headline inflation rose by 3.1% year-on-year in January from a 3.4% print in December against expectations of a much lower reading of 2.9%. Monthly CPI rose by 0.3% in January, exceeding expectations of a 0.2% print. Core CPI, which excludes food and energy, rose by 0.4%, its higher monthly growth since June, against expectations of a 0.3% raise.
Markets were anticipating a sharp drop in inflation in January, which was not realized, dashing expectations of early Fed rate cuts, and boosting the dollar. The progress of disinflation in the US is not steady, limiting the odds of a Fed rate cut before June.
Advance GDP for the final quarter of 2023 showed that the US economy expanded by 3.3% against the expectation of a more modest 2.0% growth. The US economy is expanding at a slower pace, as final GDP data have shown expansion by 4.9% in the third quarter of 2023, but economic growth in Q4 of 2023 exceeded expectations. Advance GDP Price Index for the final quarter of 2023 came in at 1.5% against expectations of 2.3% and a final print of 3.3% in the previous quarter. This is an indicator of inflation, and a lower print indicates cooling price pressures in the US.
EUR/USD dropped to the 1.080 level on Thursday, as the dollar gained strength. If the EUR/USD pair declines, it may find support at 1.069, while resistance may be encountered near 1.088.
CPI data released on Thursday for some of the Eurozone’s leading economies showed that disinflation in the EU is progressing. German CPI rose by 0.4% in January against expectations of 0.5% growth. Inflation also slowed to 2.8 year-on-year in Spain from a 3.4% print in December.
The ECB kept interest rates unchanged at 4.50% at its January meeting. ECB President Christine Lagarde stated that interest rates are currently at sufficiently high levels to bring inflation down to the central bank’s 2% target over time. Lagarde also reiterated that ECB interest rates will remain at sufficiently restrictive levels for as long as necessary. The ECB is expected to pivot to a more dovish policy later this year, but the timeline is still uncertain.
Speaking about the ECB Annual Report 2022 on Monday in Strasbourg, Lagarde emphasized that wage growth in the Eurozone remains robust and hinted that the central banks are considering interest rate cuts later in the year. ECB Yannis Stournaras, however, ruled out the possibility of a rate cut before June.
Headline inflation in the EU dropped to 2.8% year-on-year in January from 2.9% in December, which was confirmed by final CPI data released on Thursday. Core inflation, which excludes food and energy, cooled to 3.3% from 3.4% in December, as expected.
Flash GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero, as anticipated. The Eurozone economy does not show sufficient signs of recovery and is on the brink of recession. EU economy contracted by 0.1% in the third quarter of 2023 and barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1.
GBP/USD extended losses on Thursday, dropping to the 1.261 level. If the GBP/USD rate goes up, it may encounter resistance near 1.270, while support may be found near 1.257.
The BOE maintained its official rate at 5.25% at its latest meeting, as expected. In addition, the BOE updated its inflation outlook, predicting that inflation will drop to the BOE’s 2% target in the second quarter of the year. This reinforced the notion that the central bank is preparing to cut interest rates. BOE Governor Andrew Bailey has stressed that inflationary pressures are cooling and that further rate hikes are not required.
Market expectations of BOE rate cuts are putting pressure on Sterling. Markets had been pricing in aggressive rate cuts of over 100 basis points this year. In the past couple of weeks, however, rate cut expectations have become more moderate, dropping to 70bp.
The British economy remains fragile and may force the BOE to pivot to a more dovish policy. British GDP data released on Thursday showed that the country has slipped into recession. Monthly GDP dropped by 0.1% in December, from a 0.2% growth in November, although market analysts were predicting an even larger drop by 0.2%. Preliminary quarterly GDP data revealed that the British economy contracted by 0.3% in the final quarter of 2023, against expectations of 0.1% contraction and 0.1% contraction in the third quarter of 2023. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter.
British headline inflation remained steady at 4.0% year-on-year in January, against expectations of a 4.1% print. Annual Core CPI, which excludes food and energy, grew at the same pace of 5.1% as December and November, against the 5.1% forecast. British inflation is expected to fall towards the BOE’s 2% goal in the coming months, relieving some of the pressure on the central bank to keep high-interest rates.
USD/JPY declined on Thursday, even as the dollar gained strength. The currency rate tested the 149.5 level support before paring some losses. If the USD/JPY pair declines, it may find support near 149.5. If the pair climbs, it may find resistance near 151.0.
Inflation in Japan exceeded forecasts this week, reigniting expectations of a BOJ shift to a more hawkish policy and providing support for the Yen. BOJ Core CPI on Thursday remained at 2.6% year-on-year in January against expectations of 2.3%. In addition, according to National Core CPI data released on Tuesday, headline inflation rose by 2.0% year-on-year in January from 2.3% in December. Even though price pressures eased, January’s print exceeded expectations of a 1.9% growth in inflation. Tokyo Core CPI also dropped to 1.6% in January from 2.1% in December.
BOJ member Hajime Takata stated on Thursday that the central banks’ goal of 2% inflation is ‘finally in sight’, boosting the Yen. Takata added that it is ‘necessary to consider shifting gears from extremely powerful monetary easing’, and that the BoJ should ‘respond nimbly and flexibly toward an exit’, hinting that the BOJ may be preparing to pivot to a more hawkish policy.
The Yen has retreated to its lowest level in three months in the past two weeks causing alarm in Japanese government officials. The BOJ has intervened at least twice in 2022 to support the Yen by selling dollars and buying Yen to support the country’s currency. Japanese officials have been issuing warnings against opportunistic short sellers of the Yen, hinting at another intervention to support the currency.
The BOJ kept all policy levers unchanged at its January meeting, maintaining its ultra-easy monetary policy. The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. The BOJ has so far maintained its dovish bias as other major central banks, and especially the Fed, have raised interest rates to high levels.
BOJ Governor Kazuo Ueda has hinted at a policy shift down the road. Ueda stated that the likelihood of Japan sustainably achieving the bank's 2% inflation target was gradually increasing. Ueda has also stated that there is a high chance for easy monetary conditions to continue even after the central bank ends its negative interest rate policy.
An immediate policy shift is not expected yet, but markets are pricing in the first BOJ rate hike in April with over 50% probability. A rate hike by June is considered almost certain, with market odds giving over 90% probability of a shift in the BOJ’s monetary policy by June. Only a small rate hike of 10bps is considered likely, which would bring the BOJ’s interest level from negative to zero.
Preliminary GDP data for the final quarter of the year showed that Japan's economy contracted by 0.1% against expectations of expansion by 0.2% and 0.7% contraction in the third quarter. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking. Preliminary GDP Price Index data showed a 3.8% annual expansion in Q4, versus 5.0% in the previous quarter. This is a measure of inflation, which shows that inflationary pressures are dropping in Japan. Recession concerns and cooling inflation shrink the odds of a BOJ hawkish pivot in the coming months.
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Written by:
Myrsini Giannouli
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