Dollar rises ahead of US inflation data

Important calendar events

• JPY: BSI Manufacturing Index, PPI
• USD: CPI and Core CPI, Federal Budget Balance

USD

The dollar strengthened on Tuesday, and the dollar index rose from 106.1 to 106.4. US treasury yields also strengthened, with the 10-year bond yield rising from 4.20% to 4.23%. 

The US Federal Reserve cut interest rates by 25 basis points in November to a target range of 4.50% to 4.75%. The Fed launched its easing cycle in September, with an aggressive 50-bp rate cut, signaling the end of its restrictive monetary policy. Fed Chair Jerome Powell has stated that the progress of disinflation is steady, and the labor market is strong, permitting a shift towards a more neutral monetary policy. 

However, persistent price pressures may prevent the Federal Reserve from pivoting to a less restrictive monetary policy. US inflation is proving to be sticky despite the Federal Reserve’s efforts to bring it down to its 2.0% target. Headline inflation rose to 2.6% year-on-year in October from 2.4% in September. 

Preliminary GDP data for the third quarter of the year showed that the US economy expanded by only 2.8% in the third quarter of 2024, after rising by 3.0% in the second quarter of the year and by 1.4% in the first quarter of the year, while markets were anticipating 3.0% growth in the third quarter of 2024. The US economy is suffering from prolonged tightening, raising recession concerns.

Last week, labor data showed that the US jobs sector remains robust, raising Fed rate cut expectations in December to 90%. Non-farm payrolls, or NFPs on Friday showed significant improvement in November compared to October’s reading. NFPs rose by 227K in November, surpassing market expectations of 200K. 

CPI inflation data on Wednesday are expected to influence the price of the dollar strongly. Market analysts predict an uptick in US inflation in November. Monthly inflation is expected to rise by 0.3% in October, bringing annual headline inflation up to 2.7% from 2.6% in October. US PPI inflation data are due on Thursday and are also expected to show that producer prices are rising in the US, indicating that disinflation in the US is stalling. 

Several policymakers have been speaking in favor of a rate cut in December in the past few weeks, stressing, however, that the Fed’s outlook remains data-dependent. Markets are pricing in a rate cut in December with almost 90% probability. This week’s inflation data are the last major economic data due before the Fed policy meeting in December, which may prevent the Fed from cutting interest rates. 

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EUR 

EUR/USD dipped from 1.055 to 1.052 on Tuesday as the dollar gained strength. If the EUR/USD pair declines, it may find support at 1.046, while resistance may be encountered near 1.063.

The Euro is under pressure as a climate of political instability has prevailed in the Eurozone. France’s Prime Minister, Michel Barnier resigned after he lost a vote of no-confidence last week and the French government collapsed. This week, French President Emmanuel Macron is tasked with naming a new prime minister to replace Michel Barnier. Increased volatility in the EUR/USD pair is expected this week as a new government will likely be formed in France. 

Political instability in Germany is also weighing down the Euro. Germany is the Eurozone’s leading economy and the recent reports of snap elections in February are creating a climate of uncertainty. German Chancellor Scholz is expected to call for a vote of confidence on Wednesday. If he fails to secure the votes of the absolute majority of the German Parliament, he will likely have to call for elections in February.

The ECB lowered its benchmark interest rate by 25 basis points in October, bringing its main refinancing rate to 3.40%. The ECB started its easing cycle in June, lowering interest rates by 25bps for the third time this year in October. 

This coming week markets will focus on the ECB rate decision on Thursday. The ECB has already cut interest rates three times this year by a total of 75 basis points. A rate cut of 25 basis points is fully priced in this week, while some market analysts anticipate an even steeper rate cut of 50 bps. Most ECB policymakers, however, have been vocal about the merits of gradual rate cuts. The ECB is expected to cut interest rates up to five more times next year until neutral policy settings are reached. Traders will pay special attention to ECB President Christine Lagarde’s press conference after the policy meeting on Thursday, for hints into the central bank’s rate outlook.

On the data front, Investor morale in the eurozone dropped to its lowest level since November 2023 according to data released on Monday. The Sentix index for the eurozone to -17.5 in December, n from -12.8 in November, against estimates of a -13.5 print.

Eurozone inflation remains above the ECB’s 2% target and may prevent the ECB from cutting interest rates in December. Eurozone inflation rose to 2.3% year-on-year in November from 2.0% in October, which was in line with expectations. Core CPI, which excludes food and energy, remained steady at 2.7% in November, against expectations of a 2.8% print. 

Flash GDP data showed that the Eurozone economy expanded by 0.4% in Q3 of 2024, rising from 0.2% in Q2. The Eurozone economy also expanded by 0.3% in the first quarter of 2024. The economic outlook of the EU remains fragile as prolonged tightening has brought the Euro area economy to the brink of recession.

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GBP 

The Sterling declined against the rivaling dollar on Tuesday and GBP/USD dropped from 1.274 to 1.276. If the GBP/USD rate goes up, it may encounter resistance at 1.281, while support may be found near 1.261.  

At the latest BOE policy meeting, MPC members voted with a strong majority of 8-1 to cut rates to 4.75%. Bank of England Governor Andrew Bailey stated that the central bank intends to adopt a gradual approach to cutting interest rates. This would give policymakers time to assess the impact of the Government’s new budget on inflation. 

CPI data showed an uptick in British inflation in October, which may prevent the BOE from cutting interest rates further. Headline inflation in the UK rose to 2.3% year-on-year in October from 1.7% in September, surpassing expectations of 2.2%. Core annual inflation, which excludes food and energy, climbed to 3.2% in October from 3.2% in September against 3.1% anticipated. 

GDP data showed that the British economy contracted by 0.1% % in September, falling short of expectations of 0.2% expansion. In addition, Preliminary GDP data for the third quarter of the year showed that the British economy expanded by just 0.1% against expectations of 0.2% expansion. In addition, GDP data for the second quarter of 2024 were revised downward to reflect 0.5% growth against initial estimates of 0.6%. 

This coming week the most important data in the economic calendar for the UK are the monthly GDP data due on Friday. Markets anticipate that the British economy started to expand again by 0.1% in October, after falling into contractionary territory in September.

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JPY

The Yen extended losses on Tuesday and USD/JPY rose from 151.2 to 150.1, as expectations of a BOJ rate hike this month dropped. If the USD/JPY pair declines, it may find support at 148.4. If the pair climbs, it may find resistance at 154.7. 

The USD/JPY rose above the 150.0 level this week, which is considered a line in the sand for an intervention in support of the Yen. Expectations of a BOJ rate hike in December have been fluctuating strongly in the past couple of weeks, creating volatility in Yen's price. This week, rate hike expectations at the next BOJ policy meeting on December 19th dropped, putting pressure on the Yen.

The BOJ maintained its current monetary policy guidelines steady and its interest rate at 0.25% at its latest policy meeting. The BOJ had pivoted to a more hawkish policy at its meeting in July, raising interest rates by 15 basis points, the BOJ’s largest rate hike since 2007. The BOJ had already hiked interest rates once more in March, ending its negative interest rate policy. 

BOJ Governor Kazuo Ueda’s forward guidance was hawkish. Ueda hinted at another rate hike in the following months, if economic and inflationary conditions are met. The BOJ will likely pivot to a more restrictive monetary policy in the following months, which will provide some much-needed support for the Yen. At the same time, the US is easing interest rates, moving towards a less restrictive monetary policy, which is slowing down the USD/JPY’s ascent.

Inflation in Japan is on the rise, raising the odds of a BOJ rate hike in December and providing support for the Yen. Tokyo Core CPI came in at 2.3% annually in November, beating expectations of 2.0% and far exceeding October’s print of 1.8%. In addition, Headline inflation in Japan rose by 2.3% year-on-year in October against expectations of a 2.2% print according to CPI data released on Wednesday. BOJ Core CPI, however, dropped to 1.5% year-on-year in October from 1.7% in September against expectations of 1.8%. 

Final GDP data for the third quarter of the year on Monday showed that Japan’s economy expanded by 0.3%, exceeding initial estimates of 0.2%, but down from 0.7% in the second quarter. The Japanese economy is expanding, after shrinking by 0.5% in the first quarter of the year.

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Written by:
Myrsini Giannouli

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