Important calendar events
The dollar continued to decline on Thursday, with the dollar index dropping from a yearly high of 107.3 earlier in the week to 106.4. US bond yields also eased, with the US 10-year bond yield climbing down from a 16-year high of 4.86% to 4.71%. Rising US yields and increased rate hike expectations have bolstered the dollar in the past few days. The dollar, however, had been in overbought territory and has been retreating for the past couple of days.
US Unemployment Claims ticked up last week according to data released on Thursday. Unemployment claims rose to 207K for the week ending September 28th from 205K the week before.
In September’s monetary policy meeting, FOMC members voted 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. 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.
Core PCE Price Index rose 0.1% month-on-month in August against predictions of 0.2% growth and 0.2% in July. Core PCE Price Index dropped to 3.9% year-on-year from 4.3% in July. This is the Fed’s preferred inflation gauge and a lower-than-expected print indicated that price pressures in the US are easing. Market odds in favor of a pause in rate hikes in November rose above 80% after the release of the PCE index.
US inflationary pressures are not easing just yet though, despite the Fed’s high interest rates. Headline inflation came in hotter than anticipated, climbing to 3.7% year-on-year in August from 3.2% in July versus 3.6% expected. Rising fuel costs are largely to blame for the stubbornly high inflation rates in the US.
Final GDP data for the second quarter of 2023 showed that the US economy expanded by only 2.1% in Q2 of 2023 against expectations of 2.2% growth. The final GDP price index for the 2nd quarter of the year also came in below expectations at 1.7% versus 2.0% anticipated.
Important labor data are due on Friday for the US, including Average Hourly Earnings, Non-Farm Employment Change, and Unemployment Rate, which may affect the dollar.
The Euro benefitted from the dollar’s weakness on Thursday and the EUR/USD rose to the 1.055 level. If the EUR/USD pair declines, it may find support at 1.040, while resistance may be near 1.061.
Economic activity data released on Thursday for the Euro area were optimistic, providing support for the Euro. German Trade Balance rose to 16.6B in August from 16.0B in July, indicating increased value of exported versus imported goods. French Industrial Production contracted by 0.3% in August but did not reach the 0.4% contraction predicted.
Headline inflation in the Eurozone fell to its lowest level in two years in September. Flash CPI cooled to 4.3% year-on-year in September from 5.2% in August against expectations of a 4.5% print. Core CPI Flash Estimate, which excludes food and energy, also came in cooler than anticipated. Core CPI eased to 4.5% in September from 5.3% in August versus 4.5% predicted. The ECB’s efforts to curb inflation rates are paying off, even at the cost of decreased economic growth.
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 gained strength on Thursday as the dollar declined, and the currency rate climbed to the 1.2220 level. If the GBP/USD rate goes up, it may encounter resistance near 1.227, while support may be found near 1.200.
On the data front, UK Construction PMI data released on Thursday fell short of expectations, putting pressure on the Sterling. The Construction sector fell deep into contractionary territory in September, with a print significantly below the threshold of 50 that denotes industry expansion. Construction PMI dropped to 45.0 in September from 50.8 in August against expectations of 50.0. The BOE’s high-interest rates are responsible for an increase in UK mortgages, strangling the British housing sector.
MPC member Catherine Mann delivered a hawkish speech on Monday, hinting that the BOE may not stop raising interest rates just yet. The BOE’s hawkish stance has provided support for the Sterling this week.
The British economy expanded at a higher pace than anticipated in the second quarter of 2023. A positive GDP report indicated that the economic outlook for the UK has improved and has alleviated recession fears.
Final GDP data showed that the British economy grew faster than anticipated, expanding by 0.3% in the first three months of this year, up from the 0.1% previously estimated. Final GDP data for the second quarter of the year indicated a 0.2% expansion, as expected. More importantly, the UK's economy has grown by 1.8% since the pandemic started, beating the previous estimate of a 0.2% contraction.
The BOE maintained its official rate at 5.25% at its policy meeting in September against expectations of a 25-bp rate hike. The BOE also signaled that it had reached its peak interest rate.
BOE Governor Andrew Bailey has stated 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.
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%.
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. The state of the British economy remains fragile, as prolonged tightening has taken its toll on the labor market and other vital economic sectors.
The Yen benefited from the dollar’s decline on Thursday and the currency pair dropped to the 148.4 level. If the USD/JPY pair declines, it may find support near 147.3. If the pair climbs, it may find resistance at 150.
USD/JPY rose briefly above the key 150 level earlier in the week. The currency pair then plummeted sharply, dropping as low as 147, at what many analysts consider was another intervention to bolster the Yen. The massive drop in the USD/JPY raised speculation about government involvement, although Japanese officials have not yet confirmed an intervention to support the Yen.
Many market analysts view the USD/JPY 150 level as the line in the sand for an intervention. Indeed, as soon as the currency rate touched the 150 level on Tuesday, it registered a phenomenal drop. Government officials have not confirmed that the Yen’s extreme upward movement was the result of an intervention. Japan's top currency diplomat, Masato Kanda, said he would not comment on whether Tokyo intervened in the exchange rate market. Market volatility later in the week was subdued and USD/JPY remained much lower from the 150 key level as investors were concerned about a fresh intervention.
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 government to support the ailing currency. Finance Minister Shunichi Suzuki stated on Monday that the government is closely watching FX moves with a strong sense of urgency.
Japanese authorities have stepped in before, to provide support for the Yen. The effect of such an intervention, however, is usually short-lived and cannot be sustained for long before the USD/JPY resumes its bullish momentum. The main goal of the Japanese government is to discourage speculators from excessive short-selling of the Yen.
The BOJ has maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have been moving in a hawkish direction for over a year. The Yen becomes even more vulnerable as other major central banks continue raising interest rates and the monetary policy divergence between the Fed and the BOJ becomes more pronounced.
At its policy meeting in September, the BOJ maintained its short-term interest rate target steady at -0.10% and showed no signs of relaxing its ultra-easy policy.
The minutes of the BOJ’s September meeting were released on Monday. The minutes showed that policymakers discussed the complications of a potential exit from negative interest rates, stressing that various factors must be considered when shifting their policy.
Market odds of a BOJ rate hike in January have increased above 60%. BOJ Governor Kazuo Ueda has hinted that a policy shift may finally be on the horizon.
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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