Dollar steady ahead of Fed rate decision

Important calendar events

• GBP: Claimant Count Change, Average Earnings Index, Unemployment Rate
• EUR: German IFO Business Climate, Italian Trade Balance, German ZEW Economic Sentiment, Trade Balance, ZEW Economic Sentiment
• USD: Core Retail Sales, Retail Sales, Capacity Utilization Rate, Industrial Production, Business Inventories, NAHB Housing Market Index

USD

The dollar remained steady on Monday ahead of the Fed rate decision on Thursday, and the dollar index hovered close to the 106.9 mark. US treasury yields remained firm, with the US 10-year bond yielding approximately 4.40%. 

The US Federal Reserve cut interest rates by 25 basis points in November to a target range of 4.50% to 4.75%. The Fed had already launched its easing cycle in September, with an aggressive 50-bp rate cut, signaling the end of its restrictive monetary policy. Fed Chair Jerome Powell has stated that the progress of disinflation is steady, and the labor market is strong, permitting a shift towards a more neutral monetary policy. 

Markets this week will focus on the Fed monetary policy meeting on the 18th. In the past few weeks, policymakers have been advocating a rate cut in December, and a 25-basis-point rate cut is fully priced in by markets. 

Traders will focus mostly on the Fed’s forward guidance, especially Fed Chair Jerome Powell’s press conference after the policy meeting. Increased volatility in the dollar is expected during his speech and for some time after, as markets will digest the Fed’s message. Especially important is the release of the Fed’s dot plot after the policy meeting. This is a chart that is updated quarterly and records each Fed official's projection for the central bank's interest rate. The Fed’s updated dot plot on Wednesday will determine the central bank’s rate outlook and affect market expectations of rate cuts into 2025.

US inflation is proving to be sticky despite the Federal Reserve’s efforts to bring it down to its 2.0% target. US CPI data last week showed that monthly inflation rose by 0.3% in November, the same as in October, which was in line with expectations. Headline inflation rose to 2.7% year-on-year in November from 2.6% in October, as anticipated. Core CPI, which excludes food and energy, was also within market expectations and rose by 0.3% in November.

Last week’s inflation data were the last major economic data due before the Fed policy meeting in December, which could potentially prevent the Fed from cutting interest rates. After the release of the US inflation report last week, market odds of a rate cut in December rose to 99%. The Fed’s blackout period has already begun ahead of the policy meeting on December 18th and a rate cut this week is now fully priced in. 

Preliminary GDP data for the third quarter of the year showed that the US economy expanded by only 2.8% in the third quarter of 2024, after rising by 3.0% in the second quarter of the year and by 1.4% in the first quarter of the year, while markets were anticipating 3.0% growth in the third quarter of 2024. The US economy is suffering from prolonged tightening, raising recession concerns.

This week important fundamentals that may affect the dollar include the release of Retail sales on the 17th, one day before the Fed policy meeting. Quarterly US GDP data on the 19th may also cause some volatility in the price of the dollar. Core PCE Price Index data on Friday are especially important. This is the Federal Reserve’s inflation gauge and is likely to affect market expectations of future rate cuts, especially coming so close to the Fed’s rate decision on Wednesday.

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EUR 

EUR/USD traded sideways with low volatility on Monday, oscillating around the 1.050 level. If the EUR/USD pair declines, it may find support at 1.046, while resistance may be encountered near 1.059.

The ECB lowered its benchmark interest rate by 25 basis points last week, bringing its main refinancing rate to 3.15%. This was the fourth rate cut for the ECB this year, which started its easing cycle in June and has already lowered interest rates by a total of 100 bps. More importantly, ECB President Christine Lagarde hinted at further easing in the coming months as Eurozone inflation nears the central bank’s target while the economy remains weak.

Lagarde’s press conference after the policy meeting was dovish, raising expectations of further rate cuts. Lagarde admitted that several policymakers advocated for a sharper rate cut of 50bps at December’s meeting and market expectations of future ECB rate cuts rose after Lagarde’s speech. The central bank is currently expected to cut interest rates up to five more times next year, to a total of 125bps, until neutral policy settings are reached.

The Euro is under pressure as a climate of political instability has prevailed in the Eurozone. France’s Prime Minister, Michel Barnier resigned after he lost a vote of no-confidence and the French government collapsed. Last week, French President Emmanuel Macron selected the leader of the Democratic Movement Michel Barnier to replace Michel Barnier as France’s prime minister. 

Political instability in Germany is also weighing down the Euro. Germany is the Eurozone’s leading economy and the announcement on Monday of snap elections in February is creating a climate of uncertainty. German Chancellor Scholz lost the vote of confidence on Monday, setting Germany on course for an early election on February 23rd. 

Eurozone inflation remains above the ECB’s 2% target and may prevent the ECB from cutting interest rates in December. Eurozone inflation rose to 2.3% year-on-year in November from 2.0% in October, which was in line with expectations. Core CPI, which excludes food and energy, remained steady at 2.7% in November, against expectations of a 2.8% print. 

Flash GDP data showed that the Eurozone economy expanded by 0.4% in Q3 of 2024, rising from 0.2% in Q2. The Eurozone economy also expanded by 0.3% in the first quarter of 2024. The economic outlook of the EU remains fragile as prolonged tightening has brought the Euro area economy to the brink of recession.

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GBP 

The Sterling gained strength on Monday and GBP/USD rose from 1.261 to 1.269. If the GBP/USD rate goes up, it may encounter resistance at 1.281, while support may be found near 1.260.  

At the latest BOE policy meeting, MPC members voted with a strong majority of 8-1 to cut rates to 4.75%. Bank of England Governor Andrew Bailey stated that the central bank intends to adopt a gradual approach to cutting interest rates. This would give policymakers time to assess the impact of the Government’s new budget on inflation. 

The BOE is widely expected to keep interest rates steady at its policy meeting this coming week on the 19th having cut interest rates twice already this year. Inflationary pressures in the UK are still elevated and are likely to prevent the BOE from cutting interest rates next week. Price pressures on Britain’s labor market, in particular, are causing concerns among BOE policymakers. 

CPI data showed an uptick in British inflation in October, which may prevent the BOE from cutting interest rates further. Headline inflation in the UK rose to 2.3% year-on-year in October from 1.7% in September, surpassing expectations of 2.2%. Core annual inflation, which excludes food and energy, climbed to 3.2% in October from 3.2% in September against 3.1% anticipated. 

This week, British CPI data for November are due on the 18th, a day before the BOE policy meeting,g and are likely to cause volatility in the Sterling. Markets estimate that headline inflation in the UK will rise 20 2.6% annually from a 2.3% print in October. If inflation rises according to market expectations, the odds of future BOE rate cuts will likely drop, putting pressure on the Sterling.  

GDP data released last week showed that the British economy contracted by 0.1% in October, falling short of expectations of 0.1% expansion and following a 0.1% contraction in September. After the release of the British GDP data, Goldman Sachs cut the UK's GDP growth forecast for 2024 from 1.2% to 1.0%.

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JPY

The Yen weakened on Monday ahead of the BOJ policy decision later this week and USD/JPY continued moving in an uptrend, rising from 153.5 to 154.2. If the USD/JPY pair declines, it may find support at 148.4. If the pair climbs, it may find resistance at 156.7. 

The USD/JPY rose above the 150.0 level this week, which is considered a line in the sand for an intervention in support of the Yen. Expectations of a BOJ rate hike in December have been fluctuating strongly in the past couple of weeks. According to a report by Bloomberg, some BOJ policymakers see little value in waiting until the next year to raise interest rates and may vote in favor of a rate hike next week. Market odds of a BOJ rate hike in the following months are high, but the precise timing of the rate hike remains unknown. There is no consensus within the central bank, which will likely result in some members voting in favor of a rate cut this week, but the majority opting to wait until January before raising interest rates. Currently market odds of a BOJ rate hike this week are at approximately 25%. 

The BOJ maintained its current monetary policy guidelines steady and its interest rate at 0.25% at its latest policy meeting. The BOJ had pivoted to a more hawkish policy at its meeting in July, raising interest rates by 15 basis points, the BOJ’s largest rate hike since 2007. The BOJ had already hiked interest rates once more in March, ending its negative interest rate policy. 

BOJ Governor Kazuo Ueda’s forward guidance was hawkish. Ueda hinted at another rate hike in the following months, if economic and inflationary conditions are met. The BOJ will likely pivot to a more restrictive monetary policy in the following months, which will provide some much-needed support for the Yen. At the same time, the US is easing interest rates, moving towards a less restrictive monetary policy, which is slowing down the USD/JPY’s ascent.

Inflation in Japan is on the rise, raising the odds of a BOJ rate hike in December and providing support for the Yen. Tokyo Core CPI came in at 2.3% annually in November, beating expectations of 2.0% and far exceeding October’s print of 1.8%. In addition, Headline inflation in Japan rose by 2.3% year-on-year in October against expectations of a 2.2% print. BOJ Core CPI, however, dropped to 1.5% year-on-year in October from 1.7% in September against expectations of 1.8%. 

Final GDP data for the third quarter of the year showed that Japan’s economy expanded by 0.3%, exceeding initial estimates of 0.2%, but down from 0.7% in the second quarter. The Japanese economy is expanding, after shrinking by 0.5% in the first quarter of the year. 

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Written by:
Myrsini Giannouli

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