Dollar gains strength amidst hawkish Fed expectations

Important Calendar Events

• JPY: Annual Preliminary GDP Price Index, Quarterly Preliminary GDP, Monthly Revised Industrial Production
• GBP: Empire State Manufacturing Index, Average Earnings Index, Unemployment rate, 10-y Bond Auction
• EUR: ZEW Economic Sentiment, German ZEW Economic Sentiment, Quarterly Flash Employment Change, Quarterly Flash GDP, Trade Balance
• USD: Monthly PPI and Core PPI, Empire State Manufacturing Index

USD

US Monthly CPI and Core CPI data released last week, showed inflation has reached alarming rates in the US, climbing to a 40-year high and the dollar rose amidst expectations that the Federal Reserve might tighten its monetary policy to tackle inflation. The dollar index climbed to 96.4 on Monday, benefiting from rising geopolitical tensions and anticipation of a more hawkish Fed policy. 

The Federal Reserve has so far adopted a more cautious approach to changing its monetary policy than anticipated. A more hawkish pivot in its policy was expected in the face of soaring inflation rates in the US. The recent Omicron wave through the US though, has set the US economy back, costing jobs and slowing down many business sectors. In the coming months, the US Central Bank will have to balance indicators of economic strength against rising inflation rates to determine its fiscal policy.

A number of financial and inflation indicators for the dollar will be released on Tuesday, including: Monthly PPI and Core PPI and Empire State Manufacturing Index and may cause volatility for the dollar. Especially important inflation indicators are the PPI data, which might cause volatility for the USD, as traders will use these data in an attempt to predict the Fed’s future monetary policy.

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EUR 

The EU predicts higher inflation rates in the Eurozone over the next two years than previously anticipated, based on tensions in Eastern Europe and higher energy prices. Mounting inflationary pressures in the EU seem to be finally catching up with the ECB, which might be forced to tighten its monetary policy within the year. The ECB is caught between a rock and a hard place, as soaring inflation rates in the Eurozone require aggressive tightening of the ECB’s monetary policy. The ECB seems hesitant to shift towards a more hawkish policy though, as a new debt crisis is looming in the EU, with Italian and Greek bond yields rising to pre-pandemic heights. 

The crisis between Russia and Ukraine also threatens to send inflation rates in the Eurozone even higher, as the EU relies on Russia for key commodities and especially energy-related commodities. The EU threatens Russia with heavy economic and trade sanctions in the event of an attack against Ukraine, which might backfire though, and have a heavy impact on the Eurozone. European Commission President Ursula von der Leyen stated that the EU is attempting to build a partnership for energy security with the US and other Natural Gas suppliers, in an attempt to mitigate a potential energy crisis and shield EU consumers and households from energy shortages. 

The EUR/USD fell to 1.127 on Monday, just above the 1.275 level resistance, as the dollar climbed. If the currency pair goes up, it may encounter resistance at 1.148 again and further up at 1.169, while if it falls, support may be found around 1.275 and further down at 1.118. 

On Tuesday, several indicators are scheduled to be released for the Euro, including: ZEW Economic Sentiment, German ZEW Economic Sentiment, Quarterly Flash Employment Change, Quarterly Flash GDP, Trade Balance. These are indicators of economic health and employment for Europe as a whole and the ZEW indicators reflect mostly the economic state of Germany, which is the Eurozone’s leading economy. The release of this data might cause some volatility in the currency, as traders will scan this data to gain insight into the ECB’s future plans.

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GBP 

The sterling rose last week, after the announcement of record inflation in the US ignited expectations that not only the Fed, but other major central banks would adopt more aggressive measures to combat inflation. There is wide speculation that the BOE will follow an even more aggressively hawkish policy in an effort to tackle rising inflation rates in the UK. Expectations of more frequent and sharp rate hikes have been boosting the pound as inflation hit 10-year highs. The Bank of England has already performed two back-to-back rate hikes, bringing its interest rate to 0.5%. The current inflation rate however, is around 5.1%, more than double than the BOE’s goal of 2% and expected to rise even higher, increasing the probability of additional rate hikes in the coming months.  

The uncertain political climate in the UK is putting pressure on the pound, as British PM Boris Johnson is facing opposition even from within his own party and is pressured to resign. The ‘party gate’ report into the scandal, pointed to ‘failures in leadership’ and overall dysfunction in Downing Street. This week, the results of the Metropolitan Police investigation into the matter are due, and a damning report might signal the end of Johnson’s premiership. Meanwhile, Boris Johnson is starting a tour over Europe to launch a series of diplomatic talks with allies to ‘bring Russia back from the brink’ of an attack against Ukraine. His detractors though claim that he is trying to deflect attention from the party gate scandal and is leaving behind him accusations of wrongdoing and weak leadership. 

The sterling climbed a little on Monday, as expectations that the BOE would maintain a more hawkish policy grew. The GBP/USD rate remained steady, trading around 1.352. If the GBP/USD rate goes up again, there may be resistance at the 1.375 level, while if it declines, support may be found at 1.332 and further down at 1.317. 

A number of important financial indicators are scheduled to be released for the pound on Tuesday, including: Empire State Manufacturing Index, Average Earnings Index, Unemployment rate, 10-y Bond Auction. These are indicators of economic activity and employment in the UK and their release is expected to cause some volatility for the currency, as investors will use these data in an attempt to predict the BOE’s stance over the next few months. Many investors expect another back-to-back rate hike at the BOE’s next policy meeting in March, but this will likely depend on economic, inflation and employment conditions. 

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JPY 

USD/JPY rose last week breaking through its 115.6 resistance, after US CPI data increased expectations of a more aggressive tightening of the Fed’s monetary policy to combat record inflation rates. Low inflation rates in Japan and a weakening economy are steering the BOJ towards maintaining its ultra-accommodating monetary policy. The BOJ’s dovish monetary policy is creating a gap in interest rates with other major Central Banks, especially with the Fed and the BOE. As a result, the Yen becomes less appealing to investors, pushing its value down. The Yen remains at its lowest levels in decades, creating problems for households, as imported goods, especially food and energy, are becoming increasingly expensive for Japanese households.  

The Yen dipped on Monday as the dollar climbed, with USD/JPY climbing above its 115.6 resistance but fell again to 115.5 later in the day. If the USD/JPY pair climbs further, it may find resistance at the 116 level, while if it declines, support might be found at 114.8 and further down at 113.48.

A number of financial indicators are scheduled to be released on Tuesday for the Yen and may cause some volatility in the currency. These include: Annual Preliminary GDP Price Index, Quarterly Preliminary GDP, Monthly Revised Industrial Production.

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Written by:
Myrsini Giannouli

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