Dollar steadies as markets await Powell’s testimony

Important calendar events

• GBP: BRC Retail Sales Monitor
• EUR: German Final CPI, German WPI
• USD: NFIB Small Business Index

USD

The dollar strengthened on Monday, with the dollar index rising from 108.1 to 108.3. US treasury yields remained steady, with the 10-year bond yielding 4.49%. 

The US Federal Reserve held interest rates steady at its January meeting after delivering three consecutive rate cuts in 2024. FOMC policymakers voted unanimously to maintain the federal funds range to a target range of 4.25% to 4.50%. 

The Fed’s latest monetary policy statement did not include an earlier mention that US inflation is moving towards the central bank’s 2% target. Instead, the report stated that price pressures remain elevated, which points to a prolonged pause in rate cuts. 

Fed Chair Jerome Powell delivered a mildly hawkish message after the policy meeting, stating that the Fed’s approach will remain data-driven and stressed that the central bank needs to consider potential policy changes under Trump’s administration. Market odds of another rate cut before summer are declining, with markets pricing in a rate cut in June at the earliest. Powell is due to testify about the Semi-Annual Monetary Policy Report before the Senate Banking Committee on Tuesday, and markets will focus on his testimony for hints into the Fed’s rate outlook. Powell may also testify on how the new US government’s policies are affecting the US economy and the pace of monetary policy normalization.

US President Donald Trump has been using threats of imposing trade tariffs as a negotiation tool to further his agenda with other countries. Trump has threatened that he will announce reciprocal tariffs on many countries, which would raise US import taxes to match those imposed by the country’s other trading partners. On Monday, Trump announced a 25% tariff on steel and aluminum imports for all countries importing into the US, raising concerns over global trade wars. 

If Trump goes through with these heavy tariffs, global inflation is likely to rise, and the economic outlook will worsen, thus promoting a risk aversion sentiment that boosts safe-haven assets. Concerns that US inflation will rise again are raising the likelihood that interest rates will remain at restrictive levels for longer, lowering expectations of future rate cuts.

Advance GDP data for the fourth quarter of 2024 showed that the US economy expanded by 2.3%, following a 3.1% expansion in the third quarter of 2024 and falling below market estimates of 2.7% growth. In addition, the US economy expanded by 3.0% in the second quarter of 2024 and by 1.4% in the first quarter.

Disinflation in the US is progressing, which may affect the Fed’s rate outlook. Headline inflation rose by 2.9% year-on-year in December from 2.7% in November. Monthly inflation rose by 0.4% in December against 0.3% in November. Core CPI, which excludes food and energy, rose by 0.2% in December, following a 0.3% rise in November. Core CPI rose 3.2% year-on-year in December, against a 3.3% gain in November. 

This week, we have major economic data coming up for the US, which is likely to affect the dollar. The US inflation report on the 12th is highly anticipated by traders and may determine the Fed’s rate outlook. Disinflation in the US is stalling, and headline inflation is expected to stay at 2.9% annually in January. Producer Price Index data on the 13th will provide a more complete picture of the US inflationary outlook. Again, the prognosis is not optimistic, and market analysts predict an uptick in Core PPI in January. Finally, Retail sales data on the 14th will provide information on the health of the US economy. 

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EUR 

EUR/USD traded sideways on Monday with low volatility, close to the 1.030 level. If the EUR/USD pair declines, it may find support at 1.021, while resistance may be encountered near 1.044.

The ECB lowered its benchmark interest rate by 25 basis points in January, bringing its main refinancing rate down to 2.90% from 3.15%. The central bank is currently expected to cut interest rates up to four more times in 2025, to a total of 125bps, until neutral policy settings are reached. Expectations that the ECB will return to a more normalized policy setting sooner than the Fed are putting pressure on the EUR/USD rate.

In her speech after the policy meeting, ECB President Christine Lagarde stressed that EU policymakers will not commit to a predefined rate cut path and that the central bank’s policy will remain data-driven. 

Lagarde also commented on the Eurozone GDP data released earlier on Thursday that showed that the EU economy is stagnant, stating that the ECB expects the economy to remain weak for some time. She also hinted that the trade tariffs that the US might impose may hinder economic growth and warned that increased friction in global trade could weigh on the Eurozone’s economy. Lagarde, however, denied that there is a danger of stagflation, the toxic economic mix of stagnating economy and high inflation. Lagarde admitted that inflation in the Eurozone is expected to hover around the current levels in the short term but appeared confident that inflation will come down to the central bank’s 2% target within the year. 

US President Donald Trump has threatened to impose trade tariffs on the EU. German Chancellor Olaf Scholz stated on Sunday that the European Union is ready to act immediately if Trump imposes traded tariffs on the EU. On Monday, Christine Lagarde reassured markets that Eurozone inflation is on track to reach the ECB’s 2% target within the year. 

EU CPI Flash Estimate data showed that Eurozone inflation remains above the ECB’s 2% target and may prevent the ECB from cutting interest rates further. Eurozone inflation rose to 2.5% year-on-year in January from 2.4% in December. Core CPI, which excludes food and energy, remained steady at 2.7% in January.

Preliminary Flash GDP data showed that the Eurozone economy remained stagnant in the final quarter of 2024 after expanding by 0.3% in the second quarter, raising concerns about stagflation in the EU. 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 

GBP/USD rose from 1.237 to 1.242 early on Monday but pared gains later, dropping to 1.236. If the GBP/USD rate goes up, it may encounter resistance at 1.257, while support may be found near 1.224.  

BOE policymakers cut interest rates by 25 basis points last week, and the Official Bank Rate was reduced from 4.75% to 4.5%.  Market expectations of future BOE rate cuts rose after the policy meeting, pricing in 65bps of easing by the end of 2025. 

Bank of England Governor Andrew Bailey delivered a speech that had dovish undertones, hinting at further rate cuts. Bailey, however, stressed that the BOE would need to decide on its policy on a meeting-by-meeting basis and refused to commit to a timeline or magnitude of future rate cuts.  

In addition, the BOE updated its economic forecasts after the policy meeting. The central bank currently anticipates that the British economy will grow by 0.75% by the end of 2025, and inflation will rise from 2.5% to 3.7%. Bailey stressed that even though the BOE anticipates a rise in inflation in the coming months, this does not warrant a more restrictive monetary policy. 

The British economy expanded by just 0.1% in November, following a contraction of 0.1% in October. Final GDP data for the third quarter of 2024 have shown that the British economy is stagnating, stifled by high interest rates. 

Price pressures in the UK are easing, raising the odds of a BOE rate cut in February and providing support for the Sterling. Headline inflation in the UK rose to 2.5% year-on-year in December, dropping from 2.6% in November. Core inflation, which excludes food and energy, rose by 3.2% annually in December, against a 3.5% reading in November. 

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JPY

USD/JPY traded sideways on Monday, oscillating around the 151.9 level. If the USD/JPY pair declines, it may find support at 153.1. If the pair climbs, it may find resistance at 155.8. 

Average Cash Earnings data released on Wednesday showed that wages in Japan are rising, indicating a rise in inflation. Average Cash Earnings rose by 4.8% year-on-year in December against the 3.6% expected, with November's data also revised higher to show a 3.9% rise.

The BOJ raised its interest rate by 25 basis points in January, from 0.25% to 0.50%, its highest level since 2008. In addition, the BOJ adjusted its inflation projections upward to reflect the depreciation of the yen and rising oil prices, hinting at more rate hikes down the road. Policymakers expect Japan’s inflation to rise to 2.4% in 2025, up from previous estimates of 1.9%, and above the central bank’s 2% target. 

BOJ Governor Kazuo Ueda hinted that the central bank will continue to raise interest rates if Japan’s economy continues to improve and the BOJ 2% inflation target is reached. Ueda emphasized, however, that the timeline of future rate hikes will depend on economic and inflationary conditions. Markets currently anticipate that the BOJ will raise interest rates to a peak interest of 1.00% over the next two years.

Inflation in Japan is on the rise, raising the odds of future rate hikes and providing support for the Yen. The headline Tokyo CPI inflation rose to 3.4% annually in January from 3.0% in December. Headline inflation in Japan rose by 3.0% year-on-year in December from 2.7% in November. In addition, BOJ Core CPI rose to 1.7% year-on-year in November from 1.5% in October. 

Final GDP data for the third quarter of 2024 showed that Japan’s economy expanded by 0.3%, down from 0.7% in the second quarter. The Japanese economy is expanding after shrinking by 0.5% in the first quarter of 2024.

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Written by:
Myrsini Giannouli

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