Important calendar events
The dollar rallied on hot US inflation data on Thursday, with the dollar index rising to 106.6. US bond yields also gained strength, with the US 10-year bond yielding approximately 4.7%.
US CPI on Thursday came in hotter than expected, increasing rate hike expectations, and boosting the dollar. US headline inflation in September remained at August's levels of 3.7% year-on-year, while market analysts were expecting a drop to 3.6%. CPI rose by 0.4% monthly, which was lower than the previous month’s 0.6% but exceeded expectations of a 0.3% print. Core CPI, on the other hand, which excludes food and energy, dropped to a 2-year low of 4.1% year-on-year. Monthly Core CPI grew by 0.3% in September, in line with expectations. The housing index accounted for over half of the increase and was the largest contributor to the rise in price pressures.
US PPI inflation data on Wednesday surprised on the upside. PPI rose by 0.5% in September, exceeding expectations of a 0.3% growth. Core PPI, which excludes food and energy, was also higher than expected, rising by 0.3% in September against 0.2% anticipated.
The recent crisis in Israel has increased risk-aversion sentiment, providing support for the haven dollar. Fears of the conflict between Israel and Hamas spreading further in the Middle East, have turned traders towards safer investments.
Fed rhetoric turned dovish this week putting pressure on the dollar. Several policymakers made dovish statements this week, indicating that the Fed has likely reached its rate ceiling.
Federal Reserve Vice Chair Philip Jefferson stressed on Monday that the US Central Bank needs to proceed cautiously and cited the increase in Treasury yields as a potential further restraint on the economy. FOMC member Lorie Logan also stressed that the rise in US Treasury yields will potentially achieve further economic tightening. Fed policymaker Bostic delivered a dovish speech on Tuesday, stating that interest rates are sufficiently restrictive to bring inflation down to the Fed’s 2% target.
Fed rhetoric will be one of the main drivers of the dollar in the next few weeks as the dollar’s direction greatly depends on the Fed’s policy outlook. Market odds have turned overwhelmingly in favor of an end to rate hikes this week after several FOMC members hinted that the Fed has reached its rate ceiling.
Markets anticipate that Fed interest rates will remain the same this year, with an approximately 90% probability of a pause at November’s meeting and a more than 70% probability of an end to rate hikes through 2023. This is a major shift in market odds, as estimates showed a near 50/50 chance of another rate hike this year only a week ago.
In September’s monetary policy meeting, FOMC members voted to keep interest rates unchanged at a target range of 5.25% to 5.50%. The Fed decided to pause rate hikes, but interest rates are likely to remain in restrictive territory for longer.
Core PCE Price Index dropped to 3.9% year-on-year from 4.3% in July. This is the Fed’s preferred inflation gauge and a lower-than-expected print indicated that price pressures in the US are easing.
US inflationary pressures are not easing just yet though, despite the Fed’s high interest rates. Headline inflation came in hotter than anticipated, climbing to 3.7% year-on-year in August from 3.2% in July versus 3.6% expected. Rising fuel costs are largely to blame for the stubbornly high inflation rates in the US.
Final GDP data for the second quarter of 2023 showed that the US economy expanded by only 2.1% in Q2 of 2023 against expectations of 2.2% growth. The final GDP price index for the 2nd quarter of the year also came in below expectations at 1.7% versus 2.0% anticipated.
EUR/USD plummeted on Thursday, dropping to the 1.052 level as the dollar rallied. If the EUR/USD pair declines, it may find support at 1.044, while resistance may be encountered near 1.064.
Minutes of the latest ECB meeting were released on Thursday and revealed an overall dovish outlook, putting pressure on the Euro. EU policymakers narrowly voted in favor of a rate hike in September and the minutes indicate that ECB members are content with the current rates and unlikely to raise interest rates further.
The ECB raised interest rates by 25 bp at its September monetary policy meeting, bringing its main refinancing rate to 4.50%. The ECB had the difficult task of assessing the risk to the fragile Eurozone economy against high inflation rates.
The ECB has likely reached its interest rate ceiling, putting pressure on the Euro. ECB President Christine Lagarde has signaled an end to rate hikes but has warned that interest rates will remain at sufficiently restrictive levels for as long as necessary.
The IMF released its semi-annual World Economic Outlook report this week, issuing growth downgrades for some of the EU’s leading economies. Germany was among the worst performers, with GDP outlook for 2023 and 2024 GDP declining considerably against earlier estimates.
Headline inflation in the Eurozone fell to its lowest level in two years in September. Flash CPI cooled to 4.3% year-on-year in September from 5.2% in August against expectations of a 4.5% print. Core CPI Flash Estimate, which excludes food and energy, also came in cooler than anticipated. Core CPI eased to 4.5% in September from 5.3% in August versus 4.5% predicted. The ECB’s efforts to curb inflation rates are paying off, even at the cost of decreased economic growth.
Final GDP data for the Euro area showed 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.
GBP/USD plunged to the 1.217 level as the dollar gained strength, while, at the same time, the Sterling weakened. If the GBP/USD rate goes up, it may encounter resistance near 1.242, while support may be found near 1.200.
GDP data on Thursday revealed that Britain’s economy only partially recovered in August after a sharp drop in July. The British economy expanded by 0.2% in August from a 0.6% contraction in July, in line with expectations.
Quarterly GDP data have shown that the British economy expanded at a higher pace than anticipated, expanding by 0.3% in the first three months of the year. GDP data for the second quarter of the year indicated a 0.2% expansion. More importantly, the UK's economy has grown by 1.8% since the pandemic started, beating the previous estimate of a 0.2% contraction.
The BOE maintained its official rate at 5.25% at its policy meeting in September against expectations of a 25-bp rate hike. The BOE has also signaled that it has likely reached its peak interest rate.
BOE Governor Andrew Bailey has stated that the central bank would be watching closely to see if further rate hikes are needed. Bailey also emphasized that the BOE will be holding interest rates in restrictive territory long enough to see inflation down to the bank’s 2% target.
British Inflation cooled more than expected in August, demonstrating the effectiveness of the BOE’s consistently hawkish policy. Headline inflation dropped to 6.7% year-on-year in August from 6.8% in July against expectations of 7.0%.
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. The state of the British economy remains fragile, as prolonged tightening has taken its toll on the labor market and other vital economic sectors.
BOE Governor Andrew Bailey is due to deliver speeches this week on the 13th and the 14th. Bailey’s statements will be scrutinized by traders for hints into the BOE’s monetary policy direction.
USD/JPY shot up on Thursday, climbing to the 149.8 level. If the USD/JPY pair declines, it may find support near 148.2. If the pair climbs, it may find resistance at 150.
The dollar surged on Thursday as US inflation data surprised on the upside and USD/JPY moved again close to the key 150 level.
The Yen gained strength in early trading on Tuesday, after the Kyodo news agency reported that the BOJ is considering raising its forecast for core consumer inflation this year, but the news was not sufficient to support the Yen and the currency dipped later in the day.
USD/JPY rose briefly above the key 150 level early last week, which is considered a line in the sand for an intervention. The currency pair then plummeted sharply, dropping as low as 147, at what many analysts consider was an intervention to bolster the Yen.
Japanese authorities have repeatedly warned speculators against excessive short-selling of the Yen and have stepped in before to provide support for the Yen. The effect of such an intervention, however, is usually short-lived and cannot be sustained for long before the USD/JPY resumes its bullish momentum. The main goal of the Japanese government is to discourage speculators from excessive short-selling of the Yen.
The BOJ has maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have been moving in a hawkish direction for over a year. The Yen becomes even more vulnerable as other major central banks continue raising interest rates and the monetary policy divergence between the Fed and the BOJ becomes more pronounced.
At its policy meeting in September, the BOJ maintained its short-term interest rate target steady at -0.10% and showed no signs of relaxing its ultra-easy policy.
Market odds of a BOJ rate hike in January have increased above 60%. BOJ Governor Kazuo Ueda has hinted that a policy shift may finally be on the horizon.
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 climbed to 3.3% on an annual level in August beating expectations of 3.2%.
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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