Important calendar events
The dollar gained strength on Thursday as markets had time to digest the Fed rate announcement and the dollar index dropped climbed to the 101.7 level. US Treasury yields soared, with the US 10-year bond climbing above 4.00%.
Advance US GDP data on Thursday boosted the dollar, showing that the US economy expanded by 2.5% in the second quarter of the year, against expectations of 1.8% growth. Unemployment claims data were also upbeat on Thursday, showing a drop to 221K from 228K last week. Advance GDP Price Index data, on the other hand, showed that US inflation is cooling, putting pressure on the dollar. This is a key inflation gauge, and Thursday’s data showed a drop to 2.2% in Q2 of 2023 from 4.1% in the previous quarter, against expectations of a 3.0% print.
The U.S. Federal Reserve raised interest rates by 25 basis points on Wednesday after holding its interest rate steady at its June policy meeting. Fed officials voted unanimously on Wednesday to raise the central bank’s interest rate to a target range of 5.25% to 5.50%, the highest level in 22 years.
The Fed’s decision to resume economic tightening, however, was widely anticipated and had already been priced in by markets. The dollar dropped sharply after the Fed announcement as markets were trying to interpret the Fed’s future intentions. Markets had time to digest the news on Thursday, which was more hawkish than anticipated, boosting the dollar.
The Fed’s forward guidance remained the same, stressing that future steps would be determined by several parameters, including the cumulative effect of tightening on the economy, the progress of inflation, as well as other financial developments. The Fed’s message was ambiguous, aiming to give the central bank flexibility towards adjusting its future monetary policy and adopting a data-dependent approach.
There is considerable doubt on whether the Fed will continue hiking rates after this week’s rate increase. Cooling US inflation rates have shifted Fed interest rates expectations towards a less hawkish direction putting pressure on the dollar.
US Inflation cooled significantly in June, showing that the Fed’s efforts are paying off. Headline inflation dropped sharply to 3.0% in June from 4.0% in May versus the 3.1% forecast. US monthly inflation rose by 0.2% against the 0.3% forecast, indicating that a weakening trend in inflation is prevailing. Core inflation, which excludes food and energy, dropped to 4.8% on an annual basis in June from 5.3% in May versus the 5.0% forecast. Core inflation had been particularly sticky up till now but finally dropped to the lowest since October of 2021.
Final GDP data showed that the US economy expanded by 2.0% in the first quarter of the year. Preliminary GDP data indicated a 1.3% expansion in the previous quarter, but the final print exceeded expectations. The final GDP Price Index printed 4.1% for the first quarter of 2023, indicating that inflationary pressures are not subsiding fast enough.
Several economic activity and health indicators are scheduled to be released on Thursday for the US and may affect the dollar in the wake of Wednesday’s Fed rate decision. Advance GDP data will provide more information on the state of the US economy’s health and may affect future rate decisions. In addition, Advance GDP Price Index is a primary inflation indicator, that the Fed uses.
Several economic activity and health indicators are scheduled to be released on Friday for the US. Primary among those is the Core PCE Price Index, which is the Fed’s preferred inflation gauge, and, as such, it can influence the Fed’s next rate decision.
The Euro plummeted on Thursday even as the ECB raised interest rates and EUR/USD tested the 1.094 level support. If the EUR/USD pair declines, it may find support at 1.094, while resistance may be encountered near 1.127.
The ECB raised interest rates by 25 bp at its policy meeting on Thursday, bringing its main refinancing rate to 4.25%. The rate hike was highly anticipated, however, and had already been priced in, failing to provide support for the Euro. The ECB’s forward guidance was not as decisively hawkish as anticipated. The central bank hinted that future rate decisions will be data-based.
ECB President Christine Lagarde stated that the central bank’s focus was a timely return of inflation to the 2% medium-term target, leaving the door open for another rate hike in September. Lagarde, however, remained non-committal in her press conference about the possibility of a hike in September. This is a dovish sign given Lagarde’s decisively hawkish stance in the past few months.
GDP data for the first quarter of the year showed that the Eurozone is technically entering a recession. Revised GDP showed a contraction of 0.1% for Q1 of 2023. Deteriorating economic conditions in the Eurozone may force the ECB to rethink its hawkish monetary policy.
Euro Area headline inflation fell to 5.5% year-on-year in June from 6.1% in May, against expectations of 5.6%. Final Core CPI, which excludes food and energy, rose to 5.5% on an annual level from 5.3% in May. The latest inflation print is showing that the ECB’s efforts to bring inflation down are paying off, but it will likely not be sufficient to induce the central bank to abandon its hawkish policy just yet.
The Sterling plummeted on Thursday as the dollar rallied, and GBP/USD dropped to 1.278. If the GBP/USD rate goes up, it may encounter resistance near 1.314, while support may be found near 1.274.
The BOE raised interest rates by 50 basis points at its June meeting, bringing the bank rate to 5.0%. Sticky inflation in the UK is putting pressure on BOE policymakers to increase interest rates. BOE Governor Andrew Bailey has warned that if price pressures remain persistent, further tightening would be required. Bailey vowed last week to "see the job through" by bringing down inflation and providing price stability.
The BOE is expected to continue to increase interest rates in the coming months as it fights to bring inflation down. The BOE has been following an aggressively hawkish monetary policy, aiming to bring inflation down.
Signs of cooling inflation eased some of the pressure on the BOE to maintain its aggressively hawkish policy. British inflation dropped unexpectedly in June, indicating that the BOE may not have to raise rates as high as expected. Headline inflation in the UK eased to its lowest level over the year, dropping to 7.9% year-on-year from 8.7% in May against expectations of an 8.2% print. Core CPI, which excludes food and energy, also came in at 6.9% for June compared with May's three-decade high of 7.1%, while markets were anticipating a 7.1% print.
Britain’s economy contracted by 0.1% month-on-month in May after an expansion of 0.2% in April. The British economy shrank less than expected, however, as markers were anticipating a 0.3% contraction in May. GDP was stagnant in the 3 months to May.
The Yen gained strength against the dollar on Thursday, even as the dollar rallied, and USD/JPY dropped to the 139 level. If the USD/JPY pair declines, it may find support near 137.2. If the pair climbs, it may find resistance at 142. USD/JPY declined on Thursday even as the dollar gained strength. Renewed expectations of a BOJ policy shift bolstered the Yen on Thursday.
The Yen has been weighed down by the BOJ’s persistently dovish policy, so far. The BOJ maintained its ultra-accommodating monetary policy at its June meeting, holding its short-term interest rate target steady at -0.10% and keeping its yield curve control program unchanged. The BOJ has signaled it is in no rush to change its dovish stance despite rising inflation rates.
BOJ Governor Kazuo Ueda has stated that, even though price pressures are expected to grow over the next few months, there is high uncertainty on next year's wage growth. Ueda has also stressed that more time is needed until the bank’s 2% inflation target became sustainable.
The next BOJ monetary policy meeting will be held this week, on Friday. Reports that the central bank will maintain its yield-control policy unchanged at this week's policy meeting have put pressure on the Yen.
Reports that the BOJ is considering allowing rates to float beyond the cap boosted the Yen on Thursday. Markets have been anticipating a hawkish shift in the BOJ’s policy for some time now, but BOJ officials have so far been unyielding in their dovish stance.
The BOJ Policy Statement and press conference following the policy meeting are expected to attract market attention. If BOJ's forward guidance indicates that the central bank could tweak its yield curve control in the future, the Yen might rally. On the other hand, a persistently dovish outlook may push the Yen further down.
National Core CPI rose to 3.3% in July from 3.2% in May. Inflation in Japan continues to rise contrary to BOJ’s expectations and has exceeded BOJ’s target for more than a year. BOJ Core CPI dropped slightly to 3.0% in July from 3.1% in June. Inflation in Japan remains steadily above the BOJ’s 2% target, putting pressure on businesses and households.
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.
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Written by:
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