Important calendar events
The dollar rallied on Monday, after retreating for three straight weeks on expectations of a Fed pivot. Markets seem to have priced in interest rate cuts, allowing the dollar to recover, with the dollar index rising to the 103.7 level. US treasury yields edged higher on Monday propping up the dollar, with the US 10-year bond yielding approximately 4.29%.
The dollar is under pressure, as the Federal Reserve seems to have completed its hiking cycle. Fed chair Jerome Powell delivered a speech last week that was more dovish than expected, driving the dollar down. Powell emphasized that it would be premature to talk about rate cuts but hinted that the central bank has reached its rate ceiling.
At the latest Fed meeting in November, FOMC members voted to keep interest rates unchanged at a 22-year high within a target range of 5.25% to 5.50%. The Fed has made it clear that its approach from now on will be data-driven. Markets are always ahead of events and are already pricing at an end to the Fed’s tightening policy. Market odds of another rate hike in December have dropped to zero, while markets are pricing in over 50% probability of a 25-base point rate cut in March.
The Fed’s hawkish stance over the past year has been paying off and US price pressures are cooling. Inflation in the US eased more than expected in October, driving down rate hike expectations and putting pressure on the dollar.
Headline inflation rose by 3.2% year-on-year in October from a 3.7% reading in September and against expectations of a 3.3% print. Monthly CPI remained unchanged from the previous month in October, while markets were anticipating a 0.1% raise. Core CPI, which excludes food and energy, also surprised on the downside.
Core PCE price index data confirmed that price pressures in the US are cooling. This is the Federal Reserve’s preferred inflation gauge. Core PCE price index rose by only 0.2% in October from a 0.3% growth in September. Thursday’s core PCE data were in line with expectations indicating that US inflation is easing.
US Preliminary GDP exceeded expectations boosting the dollar. Preliminary GDP showed that the US economy expanded by 5.2% in the third quarter of 2023, against expectations of a 5.0% growth and surpassing by far the 2.1% growth of Q2. The US economy seems to be recovering, putting recession fears to rest.
US fundamentals are essential this coming week, ahead of the Fed rate decision on the 13th. US Labor data, in particular, are front and center in the news. This week’s labor data are critical in assessing how much tightening the US economy can withstand. JOLTS Job Openings on Tuesday, reflect the number of new positions opening in the US.
EUR/USD edged lower on Monday, dropping below the 1.082 level. If the EUR/USD pair declines, it may find support at 1.080, while resistance may be encountered near 1.101.
The ECB decided to keep its benchmark interest rates unchanged at 4.50% in October. Markets anticipate that the ECB has hit its rate ceiling, putting pressure on the Euro. The ECB is tasked with assessing the risk to the fragile Eurozone economy against high inflation rates.
ECB President Christine Lagarde has hinted at an end to rate hikes. Lagarde has highlighted the risks to the Eurozone economy stressing that the economy is likely to remain weak for the remainder of the year. Lagarde has also repeatedly stated that it is too early to talk about rate cuts and warned that interest rates will remain at sufficiently restrictive levels for as long as necessary.
Price pressures in the EU are cooling and this will likely play a decisive role in the ECB’s future policy. Headline inflation in the Eurozone dropped to 2.4% year-on-year in November, its lowest level since July 2021, from 2.9% in October. Core CPI, which excludes food and energy, eased to 3.6% year-on-year in November from 4.2% in October.
The ECB’s efforts to curb inflation rates are paying off, even at the cost of decreased economic growth. Disinflation seems to be well underway in the EU, increasing the odds of a dovish pivot in the ECB’s monetary policy.
The economic outlook of the Eurozone is deteriorating, putting pressure on the Euro. Flash GDP data 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. The EU economy is struggling and cannot withstand much further tightening.
GBP/USD edged lower on Monday, dropping to the 1.262 level. If the GBP/USD rate goes up, it may encounter resistance near 1.273, while support may be found near 1.254.
The BOE maintained its official rate at 5.25% at its latest meeting, which was in line with expectations. The BOE has likely reached its rate ceiling but will keep interest rates on hold for a long time to bring inflation down.
BOE Governor Andrew Bailey has warned that inflation risks may need more aggressive action and stressed that the BOE will be holding interest rates in restrictive territory long enough to see inflation down to the bank’s 2% target. Even though the current restrictive policy is hurting economic growth, the BOE has no choice but to continue its battle against inflation.
British inflation cooled more than forecast in October, reinforcing expectations that the Bank of England has ended its hiking cycle and will be cutting interest rates by the middle of next year. Headline inflation in the UK rose by 4.6% year-on-year in October, registering a dramatic drop from September’s 6.7% increase. Annual Core CPI, which excludes food and energy, grew by 5.7% in October versus 6.1% in September and 5.8% forecast.
The British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Prolonged tightening has taken its toll on the labor market and other vital economic sectors.
UK GDP data revealed that the British economy remained stagnant during the third quarter of 2023. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter. Economic growth is slowing down in the UK and the country is on the brink of recession.
A combination of a struggling economy and high inflation is making the BOE’s task more difficult. Further tightening is needed to bring inflation down at the risk of tipping the British economy into recession.
USD/JPY rallied on Monday, rising to the 147.2 level. If the USD/JPY pair declines, it may find support near 145.9. If the pair climbs, it may find resistance at 149.7.
The Fed’s hawkish policy seems to be gradually coming to an end, 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.
The BOJ maintained its short-term interest rate target steady at -0.10% and that for the 10-year government bond yield around 0% set under its yield curve control, but redefined the 1.0% limit as a less restrictive ceiling rather than a rigid cap. Even though the BOJ tweaked its yield curve control policy slightly, markets were expecting a bigger shift in policy, and the Yen plummeted after the interest rate announcement.
Preliminary GDP data showed that Japan's economy contracted in the third quarter of the year. The world's third-largest economy contracted by 0.5% in the third quarter against estimates of a 0.1% 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. Preliminary GDP Price Index showed a 5.1% 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.
National Core CPI, which excludes food and energy, continued to accelerate in October increasing the odds that the BOJ will soon end its ultra-accommodating policy. National Core CPI rose by 2.9% year-on-year in October from 2.8% in September against expectations of a 3.0% print. 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 fell short of expectations on Tuesday but remained firmly above the central bank’s target. BOJ Core CPI dropped to 3.0% year-on-year in October from 3.4% in September, against expectations of a 3.4% print.
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Written by:
Myrsini Giannouli
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