Dollar gains strength on hawkish Fed commentary

Important calendar events

• EUR: Spanish Flash CPI
• GBP: FPC Meeting Minutes, FPC Statement

USD

The dollar gained strength on Tuesday, with the dollar index rising to the 104.3 level. US treasury yields remained steady, with the US 10-year bond yielding approximately 4.24%. 

The US Federal Reserve kept interest rates unchanged at its policy meeting in March, within a target range of 5.25% to 5.50%, as expected. In addition, policymakers made no adjustments to their ongoing quantitative tightening program, which was in line with expectations. 

The FOMC statement was optimistic about the state of the US economy. The central bank raised its previous forecast for US economic growth this year predicting expansion by 2.1% in 2024 compared to its previous forecast of 1.4%. The FOMC statement also emphasized that disinflation is underway, although inflationary pressures remain high.

The Fed’s forward guidance was overall dovish. The Fed’s dot plot, which outlines policymakers’ expectations for the trajectory of interest rates over several years, showed that the Fed intends to proceed with cutting interest rates this year. The Fed’s dot plot in January predicted 3 rate cuts within the year of 25 basis points each. This projection has remained unchanged, raising expectations of a dovish pivot in the following months. 

For months now, markets have been speculating as to the timeline of the Fed’s pivot to a more dovish policy. Fed Chair Jerome Powell stated that inflation is higher than expected, forcing policymakers to proceed carefully with rate cuts. Fed officials wish to see more evidence of disinflation before moving ahead with cutting interest rates. 

Odds of a rate cut in May are practically nil. Rate cut odds in June are approximately 60% and only 25 basis points of rate cuts are priced in by June. Market expectations of rate cuts are becoming more moderate as policymakers have stated that they intend to start reducing interest rates slowly. 

Hawkish Fed commentary boosted the dollar this week. FOMC members Raphael Bostic and Lisa Cook both expressed doubts on whether sticky US inflation would allow the Fed to go ahead with three rate cuts this year as planned.

On the data front, US Headline inflation rose by 3.2% year-on-year in February from a 3.1% print in January and against expectations of a steady print of 3.1%%. Monthly CPI rose by 0.4% in February, exceeding expectations of 0.3% growth. Core CPI, which excludes food and energy, also rose by 0.4% against the 0.3% raise anticipated. 

Preliminary US GDP data showed that the US economy remains robust and expanded by 3.2% in the final quarter of 2023, missing, however, market forecasts of 3.3%. The US economy is expanding slower, 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. Final GDP data are due on Thursday and may provide more information on the state of the US economy.

Core PCE Price Index, which is the Fed’s preferred inflation gauge, rose by 0.4% in January compared to December’s 0.2% growth.  On an annual basis, Core PCE was at 2.8% in January, down from 2.9% in December. Core PCE Price Index data showed that US disinflation is progressing, albeit slowly. Core PCE data for February are due on Friday and are this week’s most highly anticipated fundamentals as they may influence the Fed’s policy outlook.

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EUR 

As the dollar gained strength, EUR/USD dipped to the 1.083 level on Tuesday. If the EUR/USD pair declines, it may find support at 1.080, while resistance may be encountered near 1.094.

The ECB kept interest rates unchanged at 4.50% at its latest monetary policy meeting. The EU central bank has revised its inflation projections down to an average of 2.3% in 2024, 2.0% in 2025 and 1.9% in 2026. In addition, the ECB has revised down its growth projection for 2024 to 0.6%. Expectations of cooling inflationary pressures coupled with increased economic fragility, may induce the central bank to start cutting interest rates sooner than anticipated.

ECB President Christine Lagarde has stated that policymakers wish to see more evidence of inflation dropping to the central bank’s 2% target. Lagarde said that they expect to have sufficient data in three months, pointing to a rate cut in June, while most market analysts forecast around 90 basis points of cuts this year. 

ECB’s Madis Muller on Tuesday commented along the same lines, stating that inflationary pressures are likely to have cooled sufficiently to allow for a rate cut in June. ECB members Fabio Panetta and Philip Lane were also dovish on Monday, stating that Eurozone inflation is cooling rapidly.

Headline inflation in the EU dropped to 2.6% year-on-year in February from 2.8% in January. Euro area inflation, however, missed expectations of a greater drop to 2.5% in February. Core inflation, which excludes food and energy, has dropped to its lowest level in two years. Core inflation cooled to 3.1% in February from 3.3% in January, but also disappointed expectations of a drop to 2.9%.

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. 

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GBP 

GBP/USD dipped to 1.262 on Tuesday as the dollar rallied. If the GBP/USD rate goes up, it may encounter resistance near 1.280, while support may be found near 1.258. 

The BOE maintained its official rate at 5.25% at its policy meeting last week but showed signs of preparing for a dovish pivot. At the previous meeting in February, 2 out of 9 MPC members had voted for a rate hike, 6 voted to keep interest rates steady and one to reduce interest rates. In March’s meeting, 8 policymakers voted to keep interest rates steady and one voted in favor of a rate cut.  

BOE Governor Andrew Bailey’s statement after the meeting had dovish undertones, hinting that cooling inflationary pressures in the UK support potential interest rate cuts. In an interview with the Financial Times last week, Bailey also confirmed that British policymakers are considering cutting interest rates this year.

MPC member Catherine Mann who is a known hawk and had previously voted in favor of a rate hike, changed her voting last week, voting to keep interest rates steady. Mann explained the rationale behind this change in a speech on Monday but warned that market expectations of BOE rate cuts are too high.

Markets are pricing in the first BOE rate cut in June with approximately 60% probability, while a rate cut in August is considered almost certain. Rate cut expectations have become more moderate in the past months, with no more than 70 basis points of rate cuts priced in within the year. 

The BOE has updated its inflation outlook, predicting that inflation will drop to the BOE’s 2% target in the second quarter of the year. If the BOE’s forecasts are realized, policymakers may be induced to cut interest rates sooner.  

British headline inflation dropped to 3.4% year-on-year in February from 4.0% in January, surpassing expectations of a 3.5% print. Annual Core CPI, which excludes food and energy, fell to 4.5% in February from 5.1% in January, against 4.6% forecast. 

GDP data have shown that the British economy expanded by 0.2% in January against a 0.1% contraction in December. In addition, the British economy contracted by 0.1% in the three months to January 2024. The country’s economy returned to growth in January, raising hopes that the UK may avoid slipping into recession. The British economy remains fragile, however, and may force the BOE to pivot to a more dovish policy.

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JPY

USD/JPY rose to the 151.6 level on Tuesday. If the USD/JPY pair declines, it may find support near 148.9. If the pair climbs, it may find resistance near 151.9.

The BOJ pivoted to a more hawkish policy last week, ending its negative interest rate policy. The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. Japanese policymakers voted to raise the benchmark interest rate into the 0% - 0.1% range. 

The BOJ abandoned its ultra-easy monetary policy after almost eight years and performed its first rate hike in almost 17 years. The BOJ also abandoned bond yield curve control and dropped purchases of riskier assets. 

BOJ Governor Kazuo Ueda did not deliver clear forward guidance at his press conference after the meeting, putting pressure on the Yen. Ueda stated that accommodative financial conditions will be maintained for the time being and did not give any hints of future rate hikes.

The minutes of the latest BOJ meeting were released on Monday but offered almost no new information. Even though Japanese policymakers voted to raise interest rates, they have expressed concern over inflation not rising according to expectations. The BOJ’s 2% inflation target has not been met sustainably, which is likely to hinder policymakers from raising interest rates again soon.

Even though the BOJ voted to raise interest rates, the Yen continues to weaken as there is still a significant disparity between interest rates offered by the BOJ and those from other major central banks. 

The Yen’s weakness is causing concern to Japanese officials who have rushed this week to warn traders against speculative short selling of the Yen. Japan’s top currency diplomat Masato Kanda stated on Monday that the Japanese government is ready to take action to support the currency. Finance Minister Shunichi Suzuki reiterated this statement on Tuesday, hinting at another intervention to support the weakening Yen. Japanese authorities have intervened to support the currency in the past and may do so again if the Yen continues to decline.

On the data front, inflation in Japan remains low but is slowly rising. Tokyo Core CPI rose by 2.5% year-on-year in February from 1.6% in January. Headline inflation climbed to 2.8% year-on-year in February from 2.0% in January. BOJ Core CPI, on the other hand, retreated to 2.3% year-on-year in February from 2.6% in January against expectations of 2.5%. 

Final GDP data for the final quarter of 2023 showed that Japan's economy expanded by 0.1% against expectations of 0.3% expansion. The Japanese economy contracted by 0.7% in the third quarter and expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking. Recession concerns limit the odds of a BOJ hawkish pivot in the coming months.

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Written by:
Myrsini Giannouli

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