Important calendar events
The dollar firmed on Tuesday, with the dollar index climbing to 104.7 ahead of key US inflation data. US Treasury yields were stable, with the US 10-year bond yielding 4.27%.
The dollar is expected to be driven in the next few weeks by Fed rate hike expectations. The U.S. Federal Reserve raised interest rates by 25 basis points in July to a target range of 5.25% to 5.50%, the highest level in 22 years.
The Fed’s aggressively hawkish policy over the past year has been paying off and inflationary pressures in the US are easing. Most investors are anticipating a pause in rate hikes, but the US central bank has signaled that further tightening is possible if inflation does not go down consistently. Markets are expecting a pause in rate hikes this month but market odds of another rate hike in November are increasing.
Headline inflation rose to 3.2% in July from 3.0% in June, versus the 3.3% forecast, indicating that inflationary pressures are not decreasing consistently. US monthly CPI and Core CPI, which excludes food and energy, both rose by 0.2% in July. PPI, and Core PPI, also increased more than expected in July, both rising by 0.3%, against estimates of a 0.2% growth.
The primary drivers of the dollar this week are expected to be the US inflation data. CPI data on the 13th and PPI data on the 14th will provide a clearer picture of the broader trend in inflationary pressures and are expected to play a decisive role in future Fed rate decisions.
The US CPI report due on Wednesday is the most highly-anticipated event of the week. Market analysts are expecting an accelerated pace of consumer inflation. Headline inflation is forecast to have risen to 3.6% year-on-year in August from 3.2% in July. If Wednesday’s inflation print comes out as hot or hotter than anticipated, the dollar may rise even further. Increasing price pressures may push the Fed to continue its hawkish policy until inflation drops closer to the Fed’s 2% target.
Preliminary GDP for the second quarter of 2023 showed that the US economy expanded by only 2.1% against expectations of 2.4% growth. The preliminary GDP price index for the 2nd quarter of the year also came in below expectations at 2.0% versus 2.2% anticipated.
The Euro dropped against the dollar on Tuesday and EUR/USD dropped to the 1.070 level. If the EUR/USD pair declines, it may find support at 1.068, while resistance may be encountered near 1.080.
Economic activity data released on Tuesday for the Eurozone were mixed. German ZEW Economic data were optimistic, indicating improved economic health. The German ZEW indicator came at -11.4 in September. While a negative print indicates pessimism, markets were expecting an even lower print of -15.0, and September’s value is less pessimistic than August’s -12.3. Conversely, ZEW Economic data for the Eurozone as a whole dropped below expectations, showing a deterioration in economic health. September’s print of -8.9 was considerably worse than August’s -5.5 and failed to meet expectations of -6.2.
This week the attention of market participants will be focused on the ECB policy meeting on the 14th. The ECB raised interest rates by 25 bp at its July policy meeting, bringing its primary refinancing rate to 4.25%.
The ECB rate decision this week is expected to affect the price of the Euro considerably since market odds are currently split between a pause in rate hikes and a 25-bp rate hike. Most market analysts anticipate a complete pause in rate hikes, which will likely signal the end of rate hikes for the ECB. Deteriorating economic conditions in the Eurozone are likely to force the central bank to dial down its tightening policy.
ECB rhetoric was hawkish last week, boosting the Euro. ECB’s Peter Kazimir and Klaas Knot stressed that the central bank should raise rates further and that investors betting against an ECB rate hike would likely be in for a surprise. ECB President Christine Lagarde delivered a speech on Monday at an event hosted by the European Economics and Financial Centre, in London. Lagarde’s speech was non-committal on Monday, avoiding addressing the central bank’s rate decision next week.
Final GDP data for the Euro area were disappointing, showing that the Eurozone economy expanded by only 0.1%, in the second quarter of the year, against expectations of 0.3% growth. The Eurozone economy barely expanded in the second quarter after contracting by 0.1% in Q1 of 2023. The EU economy is struggling and cannot withstand much further tightening.
Flash CPI data for August showed that Euro Area headline inflation remained unchanged at 5.3% year-on-year against expectations of a drop to 5.1%. Core CPI, which excludes food and energy, however, dropped to 5.3% from 5.5% in July. Inflationary pressures in the Eurozone remain high, increasing the likelihood that the ECB will continue its policy of monetary tightening.
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The Sterling lost strength on Tuesday and GBP/USD dropped to 1.246 in early trading but pared some losses later in the day. If the GBP/USD rate goes up, it may encounter resistance near 1.264, while support may be found near 1.244.
UK labor data released on Tuesday were mixed and failed to provide support for the Sterling. The UK labor market is still weak, with the jobless rate climbing to 4.3% in the three months to July. Wage growth was higher than anticipated, however, and above the rate of inflation. Average weekly earnings growth in the three months to July rose to 8.5% year-on-year, exceeding expectations of 8.2%. Unemployment claims dropped to 0.9K in August from 7.3K in July, against expectations of 17.1K.
The BOE raised interest rates by 25 basis points at its latest policy meeting, bringing the bank rate to a 15-year high of 5.25%. Market odds are in favor of another 25-bp rate hike in September followed by another in November.
High inflation in the UK is putting pressure on BOE policymakers to increase interest rates. Inflation in the UK is showing signs of cooling, demonstrating the effectiveness of the BOE’s consistently hawkish policy. Headline inflation dropped to 6.8% year-on-year in July from 7.9% in June. Core CPI, which excludes food and energy, remained steady at 6.9% though. Even though inflationary pressures in the UK are easing, inflation is still high, and policymakers are likely to continue raising interest rates to bring it down.
Britain’s economy unexpectedly expanded by 0.5% month-on-month in June after contracting by 0.1% in May, beating estimates of a 0.2% growth. Preliminary GDP estimates for the second quarter of the year were also optimistic, predicting a 0.2% growth from just 0.1% in the first quarter of 2023. The state of the British economy is still precarious though, as prolonged tightening has taken its toll on the labor market and other vital economic sectors.
UK GDP data for July are scheduled to be released on Wednesday and are expected to cause some volatility in the price of the Sterling. Wednesday’s GDP data will provide important information on the country's economic growth and may influence future BOE rate decisions.
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The Yen gained strength on Monday and USD/JPY dropped to 145.8 on the back of the BOJ Governor’s hawkish comments. The Yen selloff, however, was resumed on Tuesday and the USD/JPY climbed back to 147.2. If the USD/JPY pair declines, it may find support near 145.8. If the pair climbs, it may find resistance at 148.
The BOJ recently showed signs of relaxing its ultra-easy policy recently. The central bank maintained its short-term interest rate target steady at -0.10% at its latest policy meeting in July. The BOJ, however, has loosened its yield curve control. This will maintain the rate ceiling but effectively allow rates to float beyond the cap, allowing for rises by a further 50 basis points.
BOJ Governor Kazuo Ueda hinted on Monday that a policy shift may finally be on the horizon. In an interview with the Yomiuri Shimbun newspaper on Monday, Ueda admitted the BOJ will be exploring new policy options, if economic and price conditions continue moving upward. Ueda warned that the present ultra-easy policy will continue for some time but indicated that the BOJ is considering policy adjustments further down the track.
Ueda’s unexpectedly hawkish comments boosted the Yen considerably on Monday. After a short reprieve, however, the Yen resumed its descent. Markets had time to digest Ueda’s comments by Tuesday. Even though Ueda hinted at a policy shift, a policy change is not imminent and will depend on future economic and inflation data.
The Yen has been weakening, pushed down by the BOJ’s ultra-accommodating monetary policy. The Yen’s weakness has been the subject of concern for Japanese authorities as it undermines the country’s importing potential and causes financial distress in households.
Japanese authorities have been repeatedly warning speculators against excessive short-selling of the Yen. The Yen’s continued weakness is raising market awareness of another intervention by the Japanese currency to support the ailing currency. Many market analysts view the USD/JPY 150 level as the line in the sand for another intervention.
National Core CPI dropped to 3.1% in July from 3.3% in June. Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. BOJ Core CPI dropped slightly to 3.0% in July from 3.1% in June.
Final GDP data for the second quarter of the year showed that the Japanese economy expanded by 1.2%, disappointing expectations of 1.4% growth. The final GDP Price Index showed a 3.5% annual expansion, versus 3.4% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.
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Written by:
Myrsini Giannouli
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