Important calendar events
The dollar edged higher on Thursday, with the dollar index climbing to the 103.6 level boosted by rising treasury yields. US treasury yields continued to gain strength, with the US 10-year bond yielding approximately 4.15%. Fed rate cut expectations in March are declining, boosting the dollar and treasury yields.
Economic activity data released on Thursday for the US were overall positive, providing support for the dollar. Unemployment claims went further down to 187K from 230K the week before, against expectations of a 206K print. Building permits went up to 1.50M on an annualized level in December from 1.47M in November.
Robust US economic data boosted the dollar on Wednesday. Retail sales rose by 0.6% in December versus 0.3% in November and 0.4% anticipated. Core Retail Sales, which exclude automobiles, also exceeded expectations, showing that consumer spending in the US is rising. Core retail sales rose by 0.4% in December from a 0.2% growth in November and against expectations of a 0.2% print. Industrial Production, which is a leading indicator of economic health, also grew beyond expectations. Industrial production expanded by 0.1% in December after remaining stagnant in November and against predictions of a 0.1% contraction.
The Fed kept interest rates unchanged at its December meeting, within a target range of 5.25% to 5.50%. The Federal Reserve kept its policy settings unchanged at its latest meeting in December but showed signs of a dovish pivot. The FOMC statement emphasized that inflationary pressures in the US are easing, while economic growth remains limited. The Fed’s forward guidance was more dovish than expected, hinting that the central bank is preparing to pivot to a less restrictive monetary policy.
Even though inflationary pressures remain high, markets are expecting a Fed pivot to a dovish stance this year. Markets currently anticipate more than 155 basis points of easing in 2024, compared to 130 basis points last week. Market expectations of future rate cuts are one of the primary drivers of the dollar. Markets odds of a 25 bp rate cut in March dropped below 55% this week from 70% last week boosting US treasury yields and propping up the dollar.
Traders will be focusing on Fed members’ speeches in the next few weeks for hints into the Fed’s policy outlook. Fedspeak is likely to be hawkish in the weeks to come as the central bank may try to rein in market expectations of rate cuts.
FOMC member Christopher Waller stated that the Fed does not need to ease its stance as quickly as in the past, indicating that policymakers are not in a hurry to bring interest rates down.
Headline inflation rose by 3.4% year-on-year in December from a 3.1% print in November against the expectation of a 3.2% raise. Monthly CPI rose by 0.3% in December, exceeding expectations of a 0.2% print. Core CPI, which excludes food and energy, rose by 0.3%, in line with expectations. Inflation in the US remains sticky and may put pressure on the Fed to keep interest rates at high levels for longer.
Core PCE price index rose by only 0.1% in November from a 0.2% growth in October against a 0.2% growth expected, bringing the annual rate to 3.2% from 3.4%. This is the Federal Reserve’s preferred inflation gauge and November’s print indicates that price pressures in the US are easing.
US Final GDP data showed that the US economy expanded by 4.9% in the third quarter of 2023. The US economy continues to expand, although growth was more modest than anticipated in Q3. Low economic growth may induce the Federal Reserve to pivot to a less restrictive monetary policy. Final GDP Price Index for the first quarter of the year was also revised lower, with a final print of 3.3% versus 3.6%. This is an indicator of inflation, and a lower print indicates cooling price pressures in the US.
EUR/USD edged lower on Thursday, dropping to the 1.084 level. If the EUR/USD pair declines, it may find support at 1.077, while resistance may be encountered near 1.100.
ECB policymakers voted to keep interest rates unchanged at 4.50% in December. Markets are starting to price in rate cuts this year, although ECB officials insist that discussions on a rate cut timeline have not started yet. ECB policymakers have also stressed the need to bring Euro area inflation down to the ECB’s 2% target by keeping interest rates at sufficiently restrictive levels for as long as necessary.
The minutes of December’s ECB meeting were released on Thursday and pointed to interest rates staying at high levels for some time, as policymakers are concerned about persistent inflationary pressures in the Eurozone.
ECB rhetoric this week has been hawkish, indicating that the central bank is not ready to pivot to a more accommodating policy. ECB President Christine Lagarde has stated that the central bank is making progress in steering inflation back to its 2% target but has emphasized that further efforts are required. In an interview in Bloomberg on Wednesday, Lagarde stated that ECB officials would likely support interest rate cuts in the summer, disappointing expectations of a dovish pivot in the spring.
ECB’s Joachim Nagel stated on Monday that it was too early to talk about rate cuts boosting the Euro. Nagel also stressed that inflation was still considered too high by policymakers and warned that markets are sometimes ‘over-optimistic’. Policymaker Robert Holzmann was also hawkish this week, stating that markets should not count on borrowing costs falling this year. Dutch central bank chief Klaas Knot also expressed the view that financial markets are preemptively factoring in monetary easing measures.
The ECB’s policy is starting to diverge from that of the Federal Reserve. At its latest policy meeting, the Fed signaled that interest rates would go down in 2024. Markets are pricing in the first ECB rate cuts in April, while market odds are in favor of the first Fed rate cut in March.
Final EU CPI data released on Wednesday tallied with the Flash CPI data released at an earlier date. Eurozone inflation remains sticky, indicating that the ECB still has some ground to cover to ensure that inflation drops sustainably. EU Final CPI for December came at 2.9% year-on-year from 2.4% in November. Core Flash CPI for December dropped to 3.4% from a 3.6% print in November, which was in line with expectations.
German inflation data released on Monday surprised on the upside, increasing the odds that the ECB will keep interest rates at high levels for some time. German headline inflation rose to 3.7% in December from 3.2% in November. Economic sentiment seems to be improving in the Eurozone, however. Both the Eurozone ZEW Economic Sentiment and the German ZEW Economic Sentiment exceeded expectations, pointing to an increased economic outlook.
The economic outlook of the Eurozone appears to be deteriorating and may force the ECB to pivot to a more dovish policy. The Eurozone economy does not show signs of recovery and is on the brink of recession. Revised GDP for the Euro area showed that the Eurozone economy contracted by 0.1% in the third quarter of the year, which was in line with expectations. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. Year-on-year the EU economy registered stagnation with GDP flat at 0%. The Eurozone economy is struggling and cannot withstand much further tightening.
GBP/USD traded sideways on Thursday, oscillating around the 1.267 level. If the GBP/USD rate goes up, it may encounter resistance near 1.278, while support may be found near 1.260.
British inflation surprised to the upside on Wednesday, indicating that price pressures in the US are not easing according to the BOE’s expectations. Headline inflation rose to 4.0% year-on-year in December from 3.9% in November, against expectations of a 3.8% print. This marked the first rise in consumer inflation in 10 months, increasing the odds the BOE will keep interest rates at high levels for longer. Annual Core CPI, which excludes food and energy, grew at the same pace of 5.1% in December as in November, beating the 4.9% forecast.
British Average Earnings data released on Tuesday revealed a drop in wages in the UK. British wage growth slowed to 6.5% during the three months ending in November from a print of 7.2% in the three months ending in October. At the same time, unemployment in the UK remained steady at 4.2%.
The British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Monthly GDP rose more than expected in November, however, inspiring more optimism on the UK’s economic outlook. The British economy expanded by 0.3% in November against expectations of a 0.2% growth and 0.3% contraction in October. Final quarterly GDP data revealed that the British economy contracted by 0.1% in the third quarter of 2023, against expectations of stagnation. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter.
The BOE maintained its official rate at 5.25% at its latest policy meeting, which was in line with expectations. The central bank’s outlook remains hawkish, however, with three policy members voting to increase interest rates versus six members voting to maintain current rates.
BOE Governor Andrew Bailey has kept his hawkish stance, stressing that inflationary pressures in the UK remain high and that further tightening might be required to bring inflation down to the bank’s 2% target.
The BOE has likely reached its rate ceiling but will keep interest rates on hold for a long time to bring inflation down. Even though the current restrictive policy is hurting economic growth, the BOE has no choice but to continue its battle against inflation.
Market expectations of the BOE’s future direction reflect the need to keep interest rates in restrictive territory for longer. The BOE policy is starting to diverge from that of the FED, with market odds in favor of Fed rate cuts starting in March, but BOE rate cuts are not expected before May.
USD/JPY traded sideways on Thursday, moving close to the 148.2 level. If the USD/JPY pair declines, it may find support near 144.3. If the pair climbs, it may find resistance near 149.7.
Inflation data released on Tuesday for Japan indicated that inflationary pressures are not rising sufficiently in Japan to justify a shift to a more hawkish policy yet. PPI remained flat year-on-year in December, exceeding expectations, however, of a 0.3% decline. National Core CPI data on Friday are highly anticipated and may influence the BOJ’s future policy.
Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. Tokyo Core CPI dropped slightly to 2.1% in December from 2.3% in November. National Core CPI cooled to 2.5% year-on-year in November from 2.9% in October print. BOJ Core CPI dropped to 3.0% year-on-year in October from 3.4% in September, against expectations of a 3.4% print.
The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. The BOJ kept its policy settings unchanged at its December meeting. The central bank kept its short rate target steady at -0.10% and its yield curve control unchanged. The BOJ has also stated that it would reduce the amount of bonds it buys in its regular operations in the January-March quarter.
The BOJ’s forward guidance into 2024 was more dovish than expected, putting pressure on the Yen. In the past few months, BOJ policymakers have hinted that the central bank is preparing to pivot to a less accommodating policy. BOJ Governor Kazuo Ueda, however, has kept a dovish stance in the past few weeks, indicating that a policy pivot is not on the cards yet. Ueda stated that economic growth remains modest and that underlying inflation will gradually increase, but the BOJ requires sustainable, stable inflation before tightening its monetary policy.
The Fed has signaled a dovish pivot, relieving some of the pressure on the Yen, which has been weakened by the BOJ’s dovish policy. The BOJ has so far maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have raised interest rates to high levels.
Final GDP data for the third quarter of the year showed that Japan's economy contracted by 0.5% in the third quarter against earlier estimates of a 0.5% contraction. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking and is on the brink of recession. Final GDP Price Index showed a 5.3% annual expansion in Q2, versus 3.5% the previous quarter. This is a measure of inflation, which shows that inflationary pressures are rising in Japan, increasing the odds of a hawkish shift in the BOJ’s policy.
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Written by:
Myrsini Giannouli
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