Dollar edges lower as Fed minutes less hawkish than expected

Important Calendar Events

• JPY: Core Machinery Orders, Trade Balance
• GBP: Annual CPI and Core CPI, Monthly PPI Input and Output
• EUR: ECB Economic Bulletin, Italian Trade Balance
• All Currencies: G20 Meeting
• USD: Monthly Retail and Core Retail Sales, FOMC Meeting Minutes, Crude Oil Inventories

USD

The dollar dipped on Tuesday and early Wednesday, following reports that several Russian troops would withdraw from the Ukrainian border. The dollar is considered a safe-haven currency and rises when a risk-aversion sentiment prevails, as investors turn towards safer assets. The announcement brought hopes of de-escalation of the crisis as the probability of a diplomatic resolution to the Russia – Ukraine crisis grew and risk appetite was renewed. The dollar index fell to 95.78 early on Wednesday as Russia – Ukraine tensions eased, but remained fairly steady, as investors awaited the release of the FOMC minutes later in the day.

US inflation data released last week showed inflation has reached a 40-year high and this was supported by Producer Price Index and Core PPI data released on Tuesday, showing that prices continue to increase in the US. Indications of rising inflation support the dollar, amidst expectations that the Federal Reserve might tighten its monetary policy to tackle inflation. 

Monthly Retail and Core Retail Sales released on Wednesday and Industrial Production data were higher than expected, indicating that the US economy is moving in a positive direction. The retail sales data are indicators of economic activity and their release boosted the dollar.

However, all eyes on Wednesday were on the release of the minutes of the latest FOMC meeting. The FOMC meeting minutes were anxiously awaited by traders, who attempt to gauge the Fed’s intentions. The release of the FOMC minutes, however, did not provide clear indications of an aggressively hawkish policy as some investors expected, and the dollar retreated as low as 95.68 following their release. The Federal Reserve has so far indicated that it will tighten its monetary policy to fight soaring inflation rates in the US. It is not clear, however, to what extent the US Central Bank intends to increase its interest rates, and there is wide speculation on the subject, causing uncertainty and market volatility.

Several financial and inflation indicators for the dollar will be released on Thursday, including Unemployment Claims, Philly Fed Manufacturing Index, FOMC members’ speeches. Unemployment claims and indicators of economic activity and health are especially important at this time, as the Federal Reserve will have to ensure that future rate hikes are performed in a way that is sustainable for the US economy. In the coming months, the US Central Bank will have to balance indicators of economic strength against rising inflation rates to determine its fiscal policy.

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EUR 

Monthly EU Industrial Production data released on Wednesday, showed that the Eurozone economy is gaining strength, boosting the Euro. The ZEW indicators released on Tuesday, also showed the economic outlook in Germany to be improving, giving the Euro a boost. Indications of economic recovery in the Eurozone increase the ECB's chances to pivot towards a more hawkish policy to tackle rising inflation rates. Mounting inflationary pressures in the EU seem to be finally catching up with the ECB, which might be forced to tighten its monetary policy within the year. The ECB seems hesitant to shift towards a more hawkish policy though, as a new debt crisis is looming in the EU. 

On Monday, the German Chancellor Olaf Scholz met with his Russian counterpart, Vladimir Putin, to address Russia’s security concerns and at the same time, issue a warning that the west would impose severe sanctions against Russia in the event of an attack against Ukraine. Russia displayed a more yielding stance on Tuesday, showing a willingness to reopen dialogue and withdraw some of its troops. As there are hopes of a peaceful resolution to the crisis and diplomatic talks continue, the Euro is gaining strength. 

The Euro gained strength against the dollar early on Wednesday, supported by the release of the Eurozone financial indicators, as well as by hopes of de-escalation of the Russia – Ukraine crisis. The EUR/USD rate climbed to 1.139, boosted by the strong Euro and the weakening dollar, following the release of the FOMC minutes. If the currency pair goes up, it may encounter resistance at 1.148 again and further up at 1.169, while if it falls, support may be found around 1.275 and further down at 1.118. 

Minor financial data are scheduled to be released on Thursday for the Euro, such as ECB Economic Bulletin and Italian Trade Balance, and may cause slight volatility in the currency.

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GBP 

Employment data released on Tuesday for the UK, showed improvement in the jobs sector, supporting expectations of a more hawkish BOE policy. UK inflation data released on Wednesday showed that inflation rates in the UK have reached a 30-year peak. Annual CPI and Core CPI data released on Wednesday were higher than expected, with headline inflation rising by 5.5% within the past year, up from 5.4% last month.

Soaring inflation rates in the UK, increase the probability of another BOE rate hike and many investors expect another back-to-back rate hike on the BOE’s next policy meeting in March. There is wide speculation that the BOE will follow an aggressively hawkish policy to tackle rising inflation rates in the UK. Expectations of more frequent and sharp rate hikes have been boosting the pound, as inflation hit 10-year highs last week. The Bank of England has already performed two back-to-back rate hikes, bringing its interest rate to 0.5%. The current inflation rate, however, is around 5.1%, more than double the BOE’s goal of 2%, and is expected to rise even higher, increasing the probability of additional rate hikes in the coming months.  

The uncertain political climate in the UK is putting pressure on the pound though, as British PM Boris Johnson’s position is still precarious. This week, the results of the Metropolitan Police investigation into the ‘party gate’ scandal are due, and a damning report might signal the end of Johnson’s premiership. Meanwhile, Boris Johnson is starting a tour over Europe to launch a series of diplomatic talks with allies to ‘bring Russia back from the brink of an attack against Ukraine. His detractors though claim that he is trying to deflect attention from the party gate scandal and is leaving behind him accusations of wrongdoing and weak leadership.

The sterling was supported by the UK inflation data on Wednesday, as well as by reports of a possible de-escalation of the crisis in Ukraine. The GBP/USD rate remained mostly steady, trading around 1.356 early on Wednesday, ahead of the US FOMC minutes. GBP/USD climbed to 1.360 after the release of the Fed minutes, as the dollar retreated. If the GBP/USD rate goes up again, there may be resistance at the 1.375 level, while if it declines, support may be found at 1.332 and further down at 1.317. 

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JPY 

The Yen fell on Tuesday and continued its decline early on Wednesday, as reports of Russian troops withdrawing from the Ukrainian borders raised hopes of de-escalation of the crisis between the two countries. The Yen is considered to be a safe-haven currency and falls when risk appetite grows. 

The Yen remained steady against the dollar early on Wednesday, in anticipation of the FOMC minutes, with the USD/JPY rate testing its 115.6 resistance. USD/JPY fell to 115.35 later in the day though, as the Fed minutes were less hawkish than expected and the dollar dipped. If the USD/JPY pair climbs again, it may find resistance at the 116 level, while if it declines, support might be found at 114.8 and further down at 113.48.

The Yen remains at its lowest levels in decades, creating problems for households, as imported goods, especially food and energy, are becoming increasingly expensive for Japanese households.  Low inflation rates in Japan and a weakening economy are steering the BOJ towards maintaining its ultra-accommodating monetary policy. The BOJ’s dovish monetary policy is creating a gap in interest rates with other major Central Banks, especially with the Fed and the BOE. As a result, the Yen becomes less appealing to investors, pushing its value down. 

On Thursday, Core Machinery Orders and Trade Balance data are scheduled to be released, which are indicators of economic activity and health in Japan and may cause some volatility for the Yen. 

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Written by:
Myrsini Giannouli

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