Important calendar events
The dollar edged lower on Thursday, with the dollar index dropping below the 103.9 level. US treasury yields, on the other hand, continued to gain strength, providing support for the dollar, with the US 10-year bond yielding approximately 4.34%.
Economic activity data released on Thursday for the US were overall optimistic. Unemployment claims dropped to 201K last week from 213K the week before, against expectations of 217K. The US Manufacturing sector continues to grow, while the growth of the Services sector is slowing down. Flash Manufacturing PMI rose to 51.5 in February from 50.7 in January against expectations of a much lower print of 50.5. February’s print remains above the threshold of 50 which denotes industry growth, indicating that the US manufacturing sector is expanding at an accelerating pace. The Flash Services PMI index, on the other hand, dropped to 51.3 in February from 52.5 in January missing expectations of a print of 52.4.
The US Federal Reserve kept interest rates unchanged at its meeting in January, within a target range of 5.25% to 5.50%. The Fed, however, has removed the tightening bias from its policy statement, indicating that the central bank is preparing to pivot to a less restrictive monetary policy. Fed Chair Jerome Powell, however, has discounted the possibility of a rate cut in March.
The minutes of the latest Fed meeting were released on Wednesday and overall held few surprises. The minutes reflected the central bank’s cautious stance in moving ahead with cutting interest rates as officials want to see evidence of a sustainable drop in inflation before pivoting to a less restrictive policy.
FOMC members’ opinions are starting to diverge, and we may see a battle of doves against hawks at the next policy meeting. For the first time, policymakers are discussing openly the possibility of rate cuts sometime this year. Even though most FOMC members agree that they are not yet ready to start reducing interest rates, markets are interpreting the change in rhetoric as a sign that the Fed is considering a pivot to a more dovish policy.
Rate cut expectations have been fluctuating strongly in the past couple of weeks. The odds of a rate cut in March are below 10% from over 50% two weeks ago. Rate cut odds in May are also down to 30% from over 80% a few weeks ago. In addition, only 25 basis points of rate cuts are priced in by May, against 25-50bp before. Market expectations of rate cuts are becoming more moderate as policymakers have stated that they intend to start reducing interest rates slowly.
US inflation surprised on the upside last week boosting the dollar. US Headline inflation rose by 3.1% year-on-year in January from a 3.4% print in December against expectations of a much lower reading of 2.9%. Monthly CPI rose by 0.3% in January, exceeding expectations of a 0.2% print. Core CPI, which excludes food and energy, rose by 0.4%, its higher monthly growth since June, against expectations of a 0.3% raise.
Markets were anticipating a sharp drop in inflation in January, which was not realized, dashing expectations of early Fed rate cuts, and boosting the dollar. The progress of disinflation in the US is not steady, limiting the odds of a Fed rate cut before June.
Advance GDP for the final quarter of 2023 showed that the US economy expanded by 3.3% against the expectation of a more modest 2.0% growth. The US economy is expanding at a slower pace, as final GDP data have shown expansion by 4.9% in the third quarter of 2023, but economic growth in Q4 of 2023 exceeded expectations. Advance GDP Price Index for the final quarter of 2023 came in at 1.5% against expectations of 2.3% and a final print of 3.3% in the previous quarter. This indicates inflation and a lower print indicates cooling price pressures in the US.
EUR/USD gained strength in early trading on Thursday, touching the 1.082 level but pared gains later in the day. If the EUR/USD pair declines, it may find support at 1.069, while resistance may be encountered near 1.093.
On the data front, both the EU Services sector grew more than expected, while the Manufacturing contracted. Flash Services PMI data released on Thursday showed that the Services sector moved out of contractionary territory and started to expand in February. EU Services PMI rose to the threshold of 50 which denotes industry expansion from a 48.4 reading in January and against expectations of 48.8. The Services sector, on the other hand, contracted at a more rapid pace than anticipated. Flash Manufacturing PMI dropped to 46.1 in February from 46.6 in January against expectations of 47.0. PMI data for Germany, the Eurozone’s leading economy, was even more disappointing. Flash German manufacturing PMI sank to 42.3 in February from 45.5 in January, against 46.1 anticipated. German Flash Services PMI, however, exceeded expectations, with a print of 48.2 in February versus 47.7 in January and 48.0 expected.
Headline inflation in the EU dropped to 2.8% year-on-year in January from 2.9% in December, which was confirmed by final CPI data released on Thursday. Core inflation, which excludes food and energy, cooled to 3.3% from 3.4% in December, as expected.
Current Account data on Tuesday showed that the difference in value between imported and exported goods and services in the Eurozone rose to 31.9B in December from 22.5B in November.
Flash GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero, as anticipated. The Eurozone economy does not show sufficient signs of recovery and is on the brink of recession. EU economy contracted by 0.1% in the third quarter of 2023 and barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1.
The ECB kept interest rates unchanged at 4.50% as expected at its January meeting. The ECB press conference following the conclusion of the meeting did not hold many clues on the central bank’s policy direction. ECB President Christine Lagarde stated that interest rates are currently at sufficiently high levels to bring inflation down to the central bank’s 2% target over time. Lagarde also reiterated that ECB interest rates will remain at sufficiently restrictive levels for as long as necessary. The ECB is expected to pivot to a more dovish policy later this year, but the timeline is still uncertain.
GBP/USD spiked in early trading on Thursday, touching the 1.270 level but retreated to 1.266 later in the day. If the GBP/USD rate goes up, it may encounter resistance near 1.277, while support may be found near 1.251.
Upbeat British PMI data boosted the Sterling on Thursday. Flash Services PMI showed that the Services sector remained firmly in expansionary territory in February, with a print of 54.3, the same as in January. The British Manufacturing sector, however, continued to contract, with Manufacturing PMI rising slightly to 47.1 in February from 47.0 in January. Thursday’s PMI data confirmed that the British economy is improving, alleviating recession concerns.
BOE Governor Andrew Bailey has stressed that inflationary pressures are cooling and that further rate hikes are not required. Bailey stated on Tuesday that Britain's economy is showing signs of improvement after falling into recession in 2023. Bailey also hinted at the possibility of rate cuts within the year. BOE Deputy Governor Ben Broadbent also stated on Tuesday that interest rate cuts during 2024 were possible but this will depend on the British inflation outlook.
The BOE maintained its official rate at 5.25% at its latest meeting, as expected. In addition, the BOE updated its inflation outlook, predicting that inflation will drop to the BOE’s 2% target in the second quarter of the year. This reinforced the notion that the central bank is preparing to cut interest rates.
Market expectations of BOE rate cuts are putting pressure on Sterling. Markets had been pricing in aggressive rate cuts of over 100 basis points this year. In the past couple of weeks, however, rate cut expectations have become more moderate, dropping to 70bp.
The British economy remains fragile and may force the BOE to pivot to a more dovish policy. British GDP data released on Thursday showed that the country has slipped into recession. Monthly GDP dropped by 0.1% in December, from a 0.2% growth in November, although market analysts were predicting an even larger drop by 0.2%. Preliminary quarterly GDP data revealed that the British economy contracted by 0.3% in the final quarter of 2023, against expectations of 0.1% contraction and 0.1% contraction in 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.
British headline inflation remained steady at 4.0% year-on-year in January, against expectations of a 4.1% print. Annual Core CPI, which excludes food and energy, grew at the same pace of 5.1% as December and November, against the 5.1% forecast. British inflation is expected to fall towards the BOE’s 2% goal in the coming months, relieving some of the pressure on the central bank to keep high-interest rates.
USD/JPY edged higher on Thursday, climbing above the 150.5 level. If the USD/JPY pair declines, it may find support near 148.9. If the pair climbs, it may find resistance near 151.0.
Flash Manufacturing PMI data released on Thursday for Japan were disappointing, putting pressure on the Yen. Manufacturing PMI dropped to 47.2 in February from 48.0 in January, against expectations of 48.2. The Manufacturing index in Japan dropped further below the threshold of 50 which denotes industry expansion, indicating that the manufacturing sector is contracting at a more rapid pace.
The Yen retreated to its lowest level in three months last week causing alarm in Japanese government officials. The BOJ has intervened at least twice in 2022 to support the Yen by selling dollars and buying Yen to support the country’s currency. Japanese finance minister Shunichi Suzuki reiterated on Tuesday that Japanese authorities are closely watching currency moves with a high sense of urgency. Japanese officials have been issuing warnings against opportunistic short sellers of the Yen, hinting at another intervention to support the currency.
The BOJ kept all policy levers unchanged at its January meeting, maintaining its ultra-easy monetary policy. The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. The BOJ has so far maintained its dovish bias as other major central banks, and especially the Fed, have raised interest rates to high levels.
BOJ Governor Kazuo Ueda has hinted at a policy shift down the road. Ueda stated that the likelihood of Japan sustainably achieving the bank's 2% inflation target was gradually increasing. Ueda has also stated that there is a high chance for easy monetary conditions to continue even after the central bank ends its negative interest rate policy.
An immediate policy shift is not expected yet, but markets are pricing in the first BOJ rate hike in April with over 50% probability. A rate hike by June is considered almost certain, with market odds giving over 90% probability of a shift in the BOJ’s monetary policy by June. Only a small rate hike of 10bps is considered likely, which would bring the BOJ’s interest level from negative to zero.
Preliminary GDP data for the final quarter of the year showed that Japan's economy contracted by 0.1% against expectations of expansion by 0.2% and 0.7% contraction in the third quarter. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking. Preliminary GDP Price Index data showed a 3.8% annual expansion in Q4, versus 5.0% in the previous quarter. This is a measure of inflation, which shows that inflationary pressures are dropping in Japan. Recession concerns and cooling inflation shrink the odds of a BOJ hawkish pivot in the coming months.
Inflationary pressures are not sufficiently high in Japan to justify a shift to a more hawkish policy yet. National Core CPI data showed that Japanese inflation cooled further in December with headline inflation at 2.3% year-on-year from a 2.5% print in November. Tokyo Core CPI also dropped to 1.6% in January from 2.1% in December.
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Written by:
Myrsini Giannouli
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