The dollar remained steady on Wednesday, trading with low volatility. The dollar price remained weak, with the dollar index hovering between 106.0 and 106.6 throughout the day, as the US Senate still hangs in the balance. US Treasury yields declined, with the US 10-year bond yielding below 3.7% by the end of the day. Diminishing Fed rate hike expectations are putting pressure on US bond yields and dollar price, which had been trading in the overbought territory over the past few months.
Economic activity data released on Wednesday for the US were overall optimistic, providing support for the dollar. US retail sales were up by 1.3% in October, compared to the 1.0 predicted. Core retail sales, which exclude food and energy, grew by 1.3% in October, exceeding expectations of 0.5% growth and were higher still than September’s growth of 0.1%. Industrial production in October fell by 0.1% though, against expectations of 0.1% expansion.
The dollar collapsed last week after US inflation data for October fell below expectations, as US Monthly CPI in October rose by 0.4% against predictions of 0.6%. Annual CPI printed at 7.7%, compared to 8.2% the previous month and the 7.9% expected.
PPI data on Tuesday confirmed that US inflation is cooling faster than expected, causing the dollar to plummet. Monthly PPI for October printed at 0.2%, against expectations of 0.4%. Monthly Core PPI, which excludes food and energy, was stagnant, versus a 0.3% rise predicted and a 0.2% rise in September.
Fed rhetoric is especially important this week as it may provide hints on the US central bank’s direction after recent soft inflation data. Fed rhetoric remains hawkish, although cautiously so. The consensus between FOMC members seems to be that although inflation is cooling, further tightening will be required to bring inflation down consistently to the central bank’s 2% target.
FOMC member Chris Waller stressed on Sunday that the US central bank still has a long way to go to bring inflation down to its 2% target. He added that interest rates are going to continue to increase and will remain high until US inflation has been brought under control. Fed’s Brainard on Monday also emphasized the need to tackle inflation but pointed to a slower pace of rate hikes down the road.
Fed's Barr stated on Tuesday that the U.S. is not in recession, hinting that the economy can withstand further tightening. FOMC member Harker commented on Tuesday’s PPI inflation reading, stressing that he does not like to base policy decisions on a couple of headline figures. He admitted, however, that the Fed may consider pausing rate hikes to avoid dramatic increases and then decreasing interest rates. Fed’s Bostic emphasized that persistent inflation needs to be targeted, even at the cost of a mild recession stemming from monetary policy tightening.
The Fed’s recent increase in interest rates is attracting investors who seek higher returns providing support for the dollar. The US Federal Reserve voted to increase interest rates by 75 basis points at its latest monetary policy meeting. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate in a range of 3.75% to 4.0%.
Market expectations of future rate hikes were considerably trimmed after last week’s inflation report and were further diminished after Tuesday’s inflation print. Slowing price pressures may induce the Fed to pivot towards a more dovish policy reducing the aggressiveness of future rate hikes. Market odds are currently between a 50-bps and a 25-bps interest rate increase in December. Rate hikes are expected to taper off in 2023 as the central bank moves into a stable interest rate.
The US mid-term Congressional elections last week have put pressure on the dollar. Concerns that the Democratic party might lose control of Congress in the mid-term elections, leading to political upheaval in the US, pushed the dollar down. Over the weekend, the Democratic party announced their victory in the key State of Nevada, which would have secured control of the House for the ruling party. It seems, however, that the Democrats were too quick to rejoice, as votes are still being tallied and the battle for securing the Senate seems to be close.
Several indicators of economic activity are scheduled to be released on Thursday for the US and may cause high volatility in dollar price, such as the Philly Fed Manufacturing Index and Unemployment Claims.
The Euro gained strength in early trading on Wednesday, despite rising geopolitical tensions. Cooler than-expected US inflation print on Tuesday has put pressure on the dollar, benefitting competing currencies, such as the Euro.
EUR/USD was testing the 1.036 level resistance early on Wednesday, but climbed above this level, later on, touching 1.043. If the EUR/USD pair declines, it may find support at the parity level and further down near 0.973. If the currency pair goes up, it may encounter resistance near 1.061.
A missile landing in Poland on Tuesday threatened to bring the Russia-Ukraine war to a wider area and triggered an emergency NATO meeting on Wednesday. NATO Secretary General Jens Stoltenberg stated after the conclusion of the meeting that the deadly missile likely came from Ukraine’s air defense system.
The ECB published its Financial Stability Review on Wednesday, in which the European central bank warned of potential risks to financial stability in the euro area. The ECB report emphasized the dangers of high inflation to the stability of banks and governments in the EU and also highlighted the dangers of a poor EU economic outlook.
Eurozone GDP grew by 0.2% in the third quarter of 2022 as expected. Economic expansion is slowing down, following a 0.7% GDP growth in the second quarter. Annual EU GDP growth was also in line with expectations, printing at 2.1%.
Eurozone economic outlook is poor though, showing signs that the EU is entering a recession, limiting the ECB’s ability to raise interest rates. Analysts are predicting stagnation later this year and in the first quarter of 2023. Even though further rate hikes seem certain, the magnitude of the hikes may decrease if the EU shows signs of entering a recession. Tuesday’s GDP data seem to support this scenario. Stagflation becomes a real headache for the ECB, which will be forced to battle inflation without the support of a robust economic background.
In its latest monetary policy meeting, the ECB raised its interest rate by 75 basis points to 1.5%, the highest since 2009. Soaring EU inflation rates are forcing the central bank to hike rates aggressively to reduce price pressures. Market odds are currently in favor of a 50-bps rate hike at the ECB’s next monetary policy meeting.
Record-high Eurozone inflation data indicate that the ECB’s efforts to tackle inflation have not been successful so far. Eurozone inflation in October reached 10.7% versus September’s print of 9.9%. Price pressures continue to increase in the EU, driven primarily by energy prices.
Several economic activities and health indicators are scheduled to be released on Thursday and may affect the Euro, especially Eurozone Annual CPI and Core CPI.
The Sterling gained strength on Wednesday, boosted by surging UK inflation. GBP/USD traded around 1.190, exhibiting low volatility even after the announcement of the record-high UK inflation rates. If the GBP/USD rate goes up, it may encounter further resistance near 1.228, while support may be found near 1.133 and further down near 1.114.
The dollar’s decline last week propped up competing currencies. The Sterling, however, is under pressure from a risk aversion sentiment seeping through from crypto markets over the past few days. The collapse of the FTX crypto exchange due to liquidity problems caused market turmoil last week. The pound is also threatened by political uncertainty in the UK. Political instability has been playing a major part in the currency’s decline over the past few months, driving the pound to an all-time low.
UK inflation hit a 41-year high in October, providing support for the Sterling. Annual CPI climbed to 11.1% in October, its highest value since 1981. October’s inflation exceeded September’s print of 10.1% and expectations of 10.7%. Inflation in the UK continues to rise, mainly due to the high cost of energy. Annual core CPI, which excludes food and energy, printed at 6.5%, exceeding expectations of 6.4%. Rising UK inflation is forcing the BOE to make some tough choices against a weak economic backdrop.
British Chancellor Jeremy Hunt released a statement on Wednesday after the UK inflation report, emphasizing the need to make difficult decisions to quell inflationary pressures and assist the BOE in their assignment.
BoE Governor Andrew Bailey likely received Hunt’s comments as a criticism against the BOE for failing to bring inflation down. Bailey stated later on Wednesday that he is concerned about probable government action in financial regulation in the future and emphasized that he is opposed to the finance ministry having the authority to review regulatory judgments.
The much-anticipated fiscal plan of the new government is expected on Thursday and is reported to be a complete reversal of the previous government’s controversial budget. Instead of tax cuts, the current government is likely to go with tax hikes, which will be a tough sell on the British public. Chancellor Jeremy Hunt is also expected to cut government spending in an attempt to restore public finances.
The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down. UK monthly GDP for September dropped by a staggering 0.6%, against expectations of a more modest, 0.4% drop, indicating that the country is already in the grip of recession. Quarterly preliminary GDP for the third quarter of 2022 also came out negative on Friday, printing at -0.2%, compared to a 0.2% growth in the second quarter. The BOE predicts that the recession could last for almost two years, with expansion not expected again till mid-2024.
BOE members voted to increase interest rates by 75 bps last week, matching the Fed’s rate hike. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate up to 4.0%. Currently, the BOE’s interest rate is at 3.0% and the difference with the Fed’s rate is putting pressure on the Sterling. In addition, the BOE did not offer specific forward guidance, suggesting that future rate hikes may be softer than expected. The BOE will also be introducing another round of gilt sales this month, as they shrink their balance sheets.
The Yen remained steady on Wednesday, even after the release of pessimistic economic activity indicators for Japan. The USD/JPY rate traded below the 139.9 level to support most of the day, touching 139.4. If the USD/JPY pair declines, support might be found at 130.4. If the pair climbs, it may find resistance at 146.9 and further up at 151.9.
Economic activity indicators released on Wednesday were lower than expected, pushing the Yen down. Core Machinery Orders for September were down by 4.6%, against expectations of a 0.6% increase. Tertiary Industry Activity for September declined by 0.4%, versus an expansion of 0.6% projected and a rise of 0.7% in August. The Japanese economy remains sluggish, putting pressure on the currency.
GDP data for Japan on Tuesday were disappointing, showing that Japan’s economy shrank in the third quarter of 2022. Preliminary GDP for Q3 of 2022 shrank by 0.3%, against expectations of growth of 0.3% and a 0.9% growth in the previous quarter. The annual Preliminary GDP Price Index printed at -0.5%, indicating that the Japanese economy is contracting, mainly due to the high costs of imported energy. Japan’s economic outlook is poor, raising recession concerns for the world’s third-biggest economy.
Lower than-expected US inflation print brought the dollar down on Tuesday, benefitting competing currencies. Cooling price pressures in the US may lead the Fed to adopt a more dovish stance, reducing the aggressiveness of future rate hikes.
In its latest policy meeting, the BOJ left its monetary policy unchanged, as expected. The BOJ maintained its ultra-easy monetary policy keeping its main refinancing rate at -0.10%. Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.
Japanese authorities recently staged interventions to support the Yen, as evidenced by the currency’s sudden surges after the USD/JPY moved above the psychological level of 150. The Japanese government cannot support the Yen indefinitely, however, as continuous interventions would not be sustainable.
The USD/JPY rate is expected to hinge largely on the dollar’s movement this week, in the wake of last week’s US inflation report. Political developments in the US are also likely to affect the dollar, as the race to control the US House continues.
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