Important calendar events
The dollar gained strength on Tuesday ahead of Wednesday’s FOMC meeting and the dollar index rose above 105.3. US treasury yields, on the other hand, dipped, with the US 10-year bond yield yielding 4.41%.
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.
The next Fed rate decision is due on Wednesday, as well as the release of the US inflation report. Markets expect the Fed to keep interest rates steady on Wednesday. Fed officials have stressed that more evidence of cooling inflation is required before a policy change can be considered. Market odds of a rate cut at June’s policy meeting this week are almost zero and traders will focus mostly on the Fed’s forward guidance.
Markets will pay close attention to the Fed’s dot plot on Wednesday, which is the summary of the central bank’s economic projections. The Fed will update its dot plot on Wednesday to take into account recent inflation and economic data and provide estimates of the Fed’s interest rate outlook.
Odds of a rate cut in September are currently approximately 50% and 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.
US CPI data for April 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.
Core PCE Price index data showed that inflationary pressures in the US are easing. This is the Federal Reserve’s preferred inflation gauge and may affect the Fed’s rate outlook. Core PCE Price index rose by just 0.2% in April from 0.3% in March against expectations of 0.3% growth. Core PCE came at 2.8% on an annual basis, which was in line with expectations, marginally exceeding March’s print of 2.7%.
The US economy expanded by just 1.3% in the first quarter of the year falling considerably below the 3.4% expansion registered in Q4 of 2023. The US economy is expanding at an increasingly slower pace putting pressure on the dollar, as GDP data have shown expansion by 4.9% in the third quarter of 2023. In addition, the Preliminary GDP Price Index rose by just 3.0% in Q1, which represents a downward revision of 0.1% from the previous estimate.
EUR/USD edged lower on Tuesday, testing the 1.072 level support before paring some of the day’s losses. If the EUR/USD pair declines, it may find support at 1.072, while resistance may be encountered near 1.091.
The Euro declined on Tuesday after political turmoil in France, led to the announcement of national elections. French President Emmanuel Macron has decided to dissolve the parliament and announce a snap election on the 30th of June, putting pressure on the Euro.
The ECB lowered its Main Refinancing Rate by 25 basis points to 4.25% last week. Markets were anticipating this, however, and a rate cut had been fully priced in.
Eurozone inflation remains sticky and may slow down the pace of future rate cuts. ECB President Christine Lagarde’s statement after the meeting was perceived as slightly hawkish. Lagarde did not give many hints on the ECB’s policy outlook and stated that the central bank’s policy will remain data-driven. Market odds of future rate cuts went down after Lagarde’s statement boosting the Euro.
On the data front, headline inflation in the Euro Area accelerated to 2.6% year-on-year in May up from 2.4% in April and exceeding the forecast of 2.5%. Core CPI, which excludes food and energy, rose to 2.9% on an annual basis in May from 2.7% in April against expectations of a 2.7% print. Inflationary pressures in the Eurozone are not easing as fast as anticipated, which might hold up the ECB’s plans to lower interest rates.
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.
GBP/USD edged higher on Tuesday, rising to the 1.274 level. If the GBP/USD rate goes up, it may encounter resistance near 1.281, while support may be found near 1.264.
The Sterling gained strength on Tuesday despite disappointing UK labor data. The UK jobless rate rose to 4.4% for the three months to April exceeding expectations of 4.3%. In addition, the number of unemployed people in the UK rose to 50.4K in May from just 8.4K in April against expectations of 10.2K. On the other hand, though, average earnings for the three months to April rose to 5.9% against 5.7% anticipated. This is an indicator of consumer inflation and sticky price pressures may prevent the BOE from cutting interest rates.
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.
Inflationary pressures in the UK are not easing as fast as anticipated reducing expectations of BOE rate cuts. British headline inflation eased to 2.3% in April on an annual basis from 3.2% in March from 3.4%, exceeding expectations, however, of a more drastic drop to 2.1%. Annual Core CPI, which excludes food and energy, fell to 3.9% in April from 4.2% in March, again surpassing expectations of a 3.6% print.
The BOE had updated its inflation outlook earlier this year, predicting that inflation would drop to the BOE’s 2% target in the second quarter of the year. The BOE’s forecasts were not confirmed, however, which may force BOE policymakers to keep interest rates at restrictive levels for longer.
Currently market odds of a BOE rate cut in June are very low and even a rate cut in August is considered unlikely. Markets are pricing in a rate cut in September with a high probability, while a rate cut by November is fully priced in. Rate cut expectations shifted from two rate cuts and a total of 50 basis points of rate cuts in 2024 to a single rate cut and only a 25 bp reduction in rates within the 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 higher on Tuesday, rising to the 157.3 level. If the USD/JPY pair declines, it may find support near 153.5. If the pair climbs, it may find resistance near 157.7.
The next BOJ interest rate decision is this week on June 14th. The BOJ has already hiked rates once and is expected to keep interest rates steady this week. Reports that the central bank will consider slowing its bond purchases at its policy meeting on Friday are boosting the Yen. BOJ Governor Kazuo Ueda hinted that it would be appropriate to reduce the central bank's bond-buying as it prepares to exit its massive monetary stimulus program.
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.
On the data front, inflation in Japan remains weak. Headline inflation dropped to 2.2% year-on-year in April from 2.6% in March. BOJ Core CPI dropped to 1.8% on an annual basis in April, falling short of expectations of 2.2%. Low inflation in Japan is preventing the BOJ from raising interest rates 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.
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Written by:
Myrsini Giannouli
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