Important calendar events
The dollar remained steady on Tuesday, with the index hovering around the 104.6 level. US treasury yields remained steady, with the US 10-year bond yielding approximately 4.42%.
One of the key factors that are driving the dollar right now is the US rate outlook. As expected, the US Federal Reserve kept interest rates unchanged at its latest policy meeting, within a target range of 5.25% to 5.50%. The US Federal Reserve has held interest rates steady since last July. Fed chair Jerome Powell stated that, while future rate hikes are unlikely, US inflation has not cooled sufficiently to allow the central bank to proceed with rate cuts. The FOMC statement released after the conference emphasized that inflationary pressures in the US have eased in the past year, but the progress of disinflation is not as steady as anticipated.
For months now, markets have been speculating as to the timeline of the Fed’s pivot to a more dovish policy. Odds of a rate cut in September rose to 70% after the release of the US inflation report last week back dropped back to 60% after a barrage of hawkish Fed comments.
FOMC members Raphael Bostic and Michael Barr both appeared skeptical on Monday about ending the Fed’s restrictive monetary policy. Fed Policymaker Philip Jefferson said on Monday that it was too early to tell if the recent slowdown in inflation would last. Fed’s Bostic stated on Tuesday that he doesn’t expect a rate cut before the fourth quarter of 2024. Fed member Loretta Mester expressed optimism on Tuesday on the growth of the US economy, reinforcing the notion that policymakers are not prepared to abandon their restrictive policy yet. Several Fed speakers this week have expressed doubt on whether inflation in the US is on track to drop to the central bank’s 2% target and emphasized that more definitive evidence of disinflation is required before a policy change can be considered.
Currently, only 25-50 basis points of rate cuts are priced in within the year. Market expectations of rate cuts are becoming more moderate as policymakers have stated that they intend to start reducing interest rates slowly. The uncertainty around Fed rate expectations is likely to continue in the coming months causing volatility in Forex markets.
Signs of cooling US inflation put pressure on the dollar last week. For three straight months, from January to March, US inflation came out hotter than expected. Inflationary pressures in the US have proven to be sticky, preventing the Federal Reserve from lowering interest rates.
US CPI data for April released last week, however, showed that disinflation in the US is finally progressing. Monthly inflation rose by just 0.3% in April, falling below expectation of a 0.4% raise. More importantly, headline inflation in April eased to 3.4% on an annual basis from 3.5% in March, which was in line with expectations. Core inflation, which excludes food and energy, came in at 3.6%, its lowest reading in three years.
US GDP data for the first quarter of 2024 showed that US economic growth is slowing down. The US economy expanded by only 1.6% in the first quarter of the year, missing expectations of 2.5% and falling considerably below the 3.4% expansion registered in the final quarter of 2023. The US economy is expanding at an increasingly slower pace, as GDP data have shown expansion by 4.9% in the third quarter of 2023.
Increased demand for safe-haven assets due to rising tensions in the Middle East is boosting the dollar. The conflict between Israel and Iran is expected to influence Forex markets in the weeks to come. The crisis between Israel and Iran seems to have been diffused for the time being, although risk aversion sentiment remains high as markets anticipate future developments in the region.
This week markets will focus on Fed members’ speeches. Several Fed officials are due to deliver speeches throughout the week and traders will watch their speeches closely to gain insight into the central bank’s policy outlook.
The EUR/USD rate remained steady on Tuesday, oscillating around the 1.085 level. If the EUR/USD pair declines, it may find support at 1.076, while resistance may be encountered near 1.089.
Current account data released for the Euro area on Tuesday showed a surplus of 36 billion euros in March compared to a EUR 29 billion surplus in February and expectations of 30 billion.
The ECB left all policy settings unchanged at its latest monetary policy meeting. The European Central Bank kept interest rates unchanged at 4.50% but hinted at a dovish shift in the future. In their statement after the meeting, policymakers stressed that if Euro area inflation remains on a path to achieve the central bank’s 2% target, it would be appropriate to reduce the current level of monetary policy restriction.
The EU central bank has revised its inflation projections down to an average of 2.3% in 2024, 2.0% in 2025 and 1.9% in 2026. In addition, the ECB has revised down its growth projection for 2024 to 0.6%. Expectations of cooling inflationary pressures coupled with increased economic fragility, may induce the central bank to start cutting interest rates soon.
The ECB is expected to start cutting interest rates later this year since inflationary pressures in the Euro area are easing. ECB President Christine Lagarde stated on Tuesday that Euro area inflation is under control and pointed to a rate cut in June.
Markets are pricing in a rate cut in June, while most market analysts forecast around 75 basis points of cuts this year. ECB Vice President Luis de Guindos stated on Friday that EU policymakers are confident that inflation will drop to the central bank’s target next year.
The Euro is under pressure by expectations that the ECB will start lowering interest rates by June. The Fed is not likely to start cutting interest rates before July, putting the Euro at a disadvantage against the dollar. In addition, markets are currently pricing in 25-50 basis points of Fed rate cuts within 2024, compared to 65 bps of ECB rate cuts.
The Eurozone economy expanded by 0.3% in the first quarter of the year, which was in line with preliminary estimates. GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero. The 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.
Euro area inflation remained steady at 2.4% in April. Core CPI, which excludes food and energy, dropped to 2.7% in April from 2.9% in March. Easing price pressures in the Eurozone may encourage the ECB to start lowering borrowing costs as early as June.
The Sterling remained steady on Tuesday ahead of the British inflation report on Wednesday. GBP/USD traded sideways close to the 1.271 level with low volatility. If the GBP/USD rate goes up, it may encounter resistance near 1.289, while support may be found near 1.244.
This week key data releases for the UK might affect the GBP/USD rate. The British inflation report for April due on Wednesday, especially, might cause volatility in the price of the Sterling. Markets are anticipating a drastic drop in inflation, with headline inflation in the UK expected to drop to 2.1% year-on-year in April from 3.2% in March, touching the BOE’s target.
The BOE has updated its inflation outlook, predicting that inflation will drop to the BOE’s 2% target in the second quarter of the year. If the BOE’s forecasts are not realized, however, policymakers may be forced to keep interest rates at restrictive levels for longer.
British headline inflation eased to 3.2% year-on-year in March from 3.4% in February, surpassing expectations of a drop to 3.1%, however. Annual Core CPI, which excludes food and energy, fell to 4.2% in March from 4.5% in February, against 4.1% forecast.
The BOE kept interest rates steady at its latest monetary policy meeting. The BOE maintained its official rate at 5.25% but showed signs of preparing for a dovish pivot. The BOE’s forward guidance was dovish overall. The voting split of the nine MPC members indicated that the central bank is preparing to abandon its hawkish policy. Seven out of nine members voted for interest rates to stay the same and two members voted to lower interest rates, compared to only one member at the BOE meeting in March.
Markets are currently giving a high probability of BOE rate cuts starting in August, while a rate cut by September is fully priced in. Rate cut expectations have become more moderate in the past months, with less than 50 basis points of rate cuts expected this year.
The British economy slipped into recession last year, contracting by 0.3% in the final quarter of 2023. Monthly GDP data for February released last week, however, revealed that the British economy has narrowly avoided slipping into recession and has expanded by 0.1%. More importantly, January’s GDP was revised upwards to show an expansion of 0.3%. The British economy is fragile and may force the BOE to pivot to a more dovish policy.
USD/JPY edged lower on Tuesday dropping to the 156.2 level. If the USD/JPY pair declines, it may find support near 153.6. If the pair climbs, it may find resistance near 156.8.
Industry activity in Japan is shrinking according to data released on Monday. Tertiary Industry Activity contracted by 2.4% in March after expanding by 2.2% in February and against expectations of 0.1% growth.
The Yen’s weakness is causing concern to Japanese officials who have been warning traders against speculative short selling of the Yen. The Yen got a reprieve last week as the rivaling dollar plummeted. USD/JPY dropped sharply after the release of the US inflation report but bounced back later in the week as the dollar rallied.
Yen intervention concerns remain high, as Japanese authorities have been warning repeatedly that an intervention to support the currency might be imminent. Japanese authorities have intervened to support the currency in the past and may do so again if the Yen continues to decline. Concerns about an imminent intervention have been keeping Yen short sellers in check, providing some support for the currency.
The BOJ kept all policy settings unchanged at its latest policy meeting, despite the Yen’s recent weakness. The BOJ had pivoted to a more hawkish policy at its previous meeting in March, ending its negative interest rate policy and raising the benchmark interest rate into the 0% - 0.1% range. The Yen continues to weaken as there is still a significant disparity between interest rates offered by the BOJ and those from other major central banks. BOJ Governor Kazuo Ueda did not deliver clear forward guidance at his press conference after the meeting, putting pressure on the Yen.
Preliminary GDP data for Q1 of 2024 for Japan showed that the country has slipped into recession. Japan’s economy shrank by 0.5% in the first quarter of the year against expectations of a 0.3% drop. Japan’s economy registered a small expansion by 0.1% in the final quarter of 2023, showing that the country’s economy is shrinking. Recession concerns limit the odds of a BOJ hawkish pivot in the coming months.
Inflation in Japan remains low but is slowly rising. Headline inflation dropped to 2.6% year-on-year in March from 2.8% in February against expectations of a 2.7% print.
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Written by:
Myrsini Giannouli
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