Yen at multi-decade low ahead of BOJ meeting

Important calendar events

• JPY: Flash Manufacturing PMI
• GBP: Public Sector Net Borrowing, Flash Manufacturing PMI, Flash Services PMI
• EUR: French and German Flash Manufacturing PMI, French and German Flash Services PMI, EU Flash Manufacturing PMI, EU Flash Services PMI
• USD: Flash Manufacturing PMI, Flash Services PMI, New Home Sales, Richmond Manufacturing Index

USD

The dollar remained steady on Monday, and the index hovered around 106.1. US treasury yields retreated slightly, with the US 10-year bond yielding approximately 4.61%. 

The US Federal Reserve kept interest rates unchanged at its policy meeting in March, within a target range of 5.25% to 5.50%, as expected. The FOMC statement was optimistic about the state of the US economy and emphasized that disinflation is underway, although inflationary pressures remain high.

For months now, markets have been speculating on the timeline of the Fed’s pivot to a more dovish policy. Fed Chair Jerome Powell has stated that policymakers wish to see more evidence of disinflation before moving ahead with cutting interest rates. The Fed is carefully monitoring the progress of disinflation in the US, which is linked with the central bank’s monetary policy. 

US Headline inflation rose by 3.5% year-on-year in March exceeding February’s 3.2% print and rising above expectations of a 3.4% print. Monthly CPI rose by 0.4% in March, against expectations of 0.3% growth. Inflation in the US has proven to be sticky, resisting the Federal Reserve’s efforts to bring it down to its 2% target. 

Market expectations of rate cuts have shifted repeatedly in the past few months. Market odds of a rate cut in July are down to 40%. More importantly, only 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. Diminishing rate cut expectations are boosting US treasury yields, providing support for the dollar. 

Core PCE Price Index, which is the Fed’s preferred inflation gauge, rose by 0.3% in February compared to January’s 0.4% growth, which was in line with expectations.  On an annual basis, Core PCE dropped just below 2.8% in February, registering a marginal drop from January’s almost 2.9% print. Core PCE Price Index data showed that US disinflation is progressing, albeit slowly. Core PCE Price Index data for March are due on Friday and are expected to cause volatility in the price of the dollar.

The US economy remains robust and expanded by 3.4% in the final quarter of 2023, exceeding previous estimates of 3.2% growth. The US economy is expanding at a slower pace, however, as GDP data have shown expansion by 4.9% in the third quarter of 2023. US GDP data for the first quarter of 2024 are scheduled to be released on Thursday and are amongst this week’s most highly-anticipated fundamentals.

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. Tensions in the Middle East have been high after the recent airstrike on Iran’s embassy in Syria. Iran accused Israel of the attack and launched a retaliative drone strike on Israeli ground. Israel launched an airstrike against Iran on Friday as retaliation for the drone strikes. Israel’s retaliatory attack came after weeks of soaring tensions in the region. The attack, however, was mostly interpreted as a show of force rather than an action intended to escalate matters. Irani officials have reportedly stated that Iran does not intend to retaliate anew against Israel. 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. 

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EUR

EUR/USD traded sideways on Monday, oscillating around the 1.065 level. If the EUR/USD pair declines, it may find support at 1.060, while resistance may be encountered near 1.069.

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 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 sooner than anticipated. 

Headline inflation in the Euro area cooled to 2.4% in March from 2.6% in February. Core CPI, which excludes food and energy, dropped to 2.9% from 3.1% the previous month. Easing price pressures in the Eurozone may encourage the ECB to start lowering borrowing costs as early as June.

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 that ECB policymakers wish to see more evidence of inflation dropping to the central bank’s 2% target before cutting interest rates. Lagarde hinted that they expect to have sufficient data in three months, pointing to a rate cut in June. Market odds of a rate cut in June rose after the ECB meeting, while most market analysts forecast around 75 basis points of cuts this 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 only 50 basis points of Fed rate cuts within 2024, compared to 75 bps of ECB rate cuts.

Flash GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero, as anticipated. The Eurozone economy does not show sufficient signs of recovery and is on the brink of recession. 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. 

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GBP 

GBP/USD traded with low volatility on Monday close to the 1.234 level. If the GBP/USD rate goes up, it may encounter resistance near 1.271, while support may be found near 1.217. 

The BOE maintained its official rate at 5.25% at its policy meeting in March but showed signs of preparing for a dovish pivot. BOE Governor Andrew Bailey’s statement after the meeting had dovish undertones, stating that cooling inflationary pressures in the UK support potential interest rate cuts and hinting at two or three rate cuts within the year.

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 the 4.1% forecast. Inflationary pressures in the UK remain high and inflation may take a while to drop to the BOE’s 2% target. 

The BOE recently 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. 

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.

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JPY

USD/JPY rose again to its multi-decade high of 154.8 on Monday, its highest level since May 1990. The currency rate is trading close to the key 155.0 level, which some analysts identify as the point for a government intervention to support the Yen. If the USD/JPY pair declines, it may find support near 152.5. If the pair climbs, it may find resistance near the psychological level of 155 and above that at a multi-decade high of 160.5.

One of the key events this coming week is the BOJ monetary policy decision on the 26th. The BOJ pivoted to a more hawkish policy in March, ending its negative interest rate policy. The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. Japanese policymakers voted to raise the benchmark interest rate into the 0% - 0.1% range. 

The BOJ abandoned its ultra-easy monetary policy after almost eight years and performed its first rate hike in almost 17 years. The BOJ also abandoned bond yield curve control and dropped purchases of riskier assets. 

BOJ Governor Kazuo Ueda did not deliver clear forward guidance at his press conference after the meeting, stating that accommodative financial conditions will be maintained for the time being and did not give any hints of future rate hikes. 

Even though the BOJ voted to raise interest rates, 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. The Yen’s recent decline may force the BOJ to relinquish its accommodative policy further. Ueda stated last week that Yen's recent decline might push inflation upwards and compel the central to raise interest rates again.

Yen intervention concerns are high, as Japanese authorities have been warning repeatedly that an intervention to support the currency might be imminent. The Yen’s weakness is causing concern to Japanese officials who have been warning traders against speculative short selling of the Yen. 

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.

On the data front, 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. 

Final GDP data for the final quarter of 2023 showed that Japan's economy expanded by 0.1% against expectations of 0.3% expansion. The Japanese economy contracted by 0.7% in the third quarter and expanded by 1.2% in the second 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.

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Written by:
Myrsini Giannouli

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