Dollar gains strength on increasing rate hike expectations

Important calendar events

• JPY: Bank Lending, Current Account, Final GDP Price Index, Final GDP, Economy Watchers Sentiment
• EUR: French Final Private Payrolls, German Final CPI, Italian Quarterly Unemployment Rate
• USD: Final Wholesale Inventories, Consumer Credit

USD

The dollar gained strength on Thursday, with the dollar index remaining above the 105 level for the first time since March. US Treasury yields retreated slightly however, with the US 10-year bond yielding 4.27%. 

Upbeat labor data boosted the dollar on Thursday. US Unemployment Claims on Thursday dropped to 216K from 229K last week, against expectations of a 232K print. Unit Labor costs rose by 2.2% in the second quarter of the year, beating estimates of 1.8% raise. The price businesses pay for labor is an overall indication of inflation and economic activity. Nonfarm Productivity increased by 3.5% in Q2 of 2023 in line with expectations.

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. 

Federal Reserve Chair Jerome Powell, recently speaking at the Jackson Hole Symposium in the US, warned that the Fed is prepared to raise interest rates further to bring inflation down. 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.

Several FOMC members are due to deliver speeches throughout the week, which may affect the dollar. Market participants are expected to follow FOMC members’ speeches closely for hints into the Fed’s future policy direction. FOMC member Christopher Waller stated on Tuesday that the Fed will be examining the latest round of economic data to ascertain if more rate hikes are necessary.

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. 

Core PCE Price Index, which is the Fed’s preferred inflation gauge, fell within market expectations last week. Core PCE remained high, rising by 0.2% monthly in July, bringing the annual rate to 4.2%.

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.

TRADE USD PAIRS

EUR 

EUR/USD dipped on Thursday, dropping to the 1.068 level. If the EUR/USD pair declines, it may find support at 1.066, while resistance may be encountered near 1.094. 

The ECB raised interest rates by 25 bp at its July policy meeting, bringing its main refinancing rate to 4.25%. The central bank hinted that future rate decisions will be data-based. 

ECB rhetoric was hawkish this week, boosting the Euro. ECB’s Peter Kazimir and Klaas Knot stressed on Wednesday 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. 

Lagarde speaking at the recent Jackson Hole Symposium in the US, stressed that the Central Bank’s focus remains on attaining the 2% inflation target. Lagarde’s stance was decidedly hawkish, emphasizing that the ECB’s priority remains to keep inflation constrained. Lagarde stated that interest rates will remain high as long as necessary to bring inflation back down to the ECB’s target. 

A barrage of pessimistic economic data this week for the Eurozone decreased the likelihood of further rate hikes. Final GDP data for the Euro area on Thursday 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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GBP 

GBP/USD continued to decline on Thursday, touching the 1.244 level before paring some losses later in the day. If the GBP/USD rate goes up, it may encounter resistance near 1.274, while support may be found near 1.244. 

UK Halifax House Price Index data on Thursday showed that housing prices are declining by the most significant percentage to date, putting pressure on the Sterling. The Halifax HPI index dropped by 1.9% in August against a 0.4% decline in July and expectations of a 0.1% drop. The Halifax index is an indicator of the housing industry’s health, and it is also a barometer of consumer spending and inflation.

Monetary Policy Report Hearings on Wednesday cast doubt on future BOE rate hikes. Several MPC members believed that the BOE policy was restrictive enough already and that the British economy could not withstand further tightening. BOE Governor Andrew Bailey was less hawkish than anticipated, hinting that the BOE is approaching peak interest rates. 

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%. Speaking at the annual Jackson Hole Economic Policy Symposium in the US, BOE Deputy Governor Ben Broadbent also stressed that monetary policy may have to remain in restrictive territory for some time yet. 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 strong economic sectors. 

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JPY

The USD/JPY retreated a little on Thursday, dropping to the 147 level. If the USD/JPY pair declines, it may find support near 144.4. If the pair climbs, it may find resistance at 148. 

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.

Japan’s top currency diplomat Masato Kanda issued another warning on Wednesday, stating that the Japanese government has seen evidence of undesirable moves in the Forex market that cannot be explained by fundamentals and are intrinsically speculative. Kanda also stressed that authorities are prepared to take action against excessive short-selling of the Yen.

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. 

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. 

BOJ Governor Kazuo Ueda, speaking at the Jackson Hole symposium in the US defended the BOJ’s ultra-easy policy. Ueda stressed that underlying inflation in Japan remains below the BOJ’s target, indicating that a pivot in the central bank’s policy direction is not on the cards just yet.

Final GDP data for the first quarter of the year showed that the Japanese economy expanded by 0.7%, against a preliminary GDP print of 0.4%. The GDP data exceeded expectations, alleviating recession concerns for Japan. Final GDP Price Index showed a 2.0% annual expansion, versus 1.2% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

Several economic activity indicators are scheduled to be released on Friday for Japan especially the GDP and GDP price index, which may cause volatility in the price of the Yen.

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Written by:
Myrsini Giannouli

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