Dollar in limbo as US Senate hangs in balance

Important calendar events

• JPY: M2 Money Stock, Preliminary Machine Tool Orders
• EUR: ECB Economic Bulletin, EU Economic Forecasts, Italian Industrial Production
• USD: Monthly CPI and Core CPI, Annual CPI, Unemployment Claims, Mortgage Delinquencies, Federal Budget Balance, FOMC Financial Stability Report

USD

The dollar was mostly steady on Wednesday, trading with low volatility, with the dollar index hovering around the 110 level during the day. US Treasury yields declined, with the US 10-year bond yield dropping to 4.1% 

The US mid-term Congressional elections on Tuesday have put pressure on the dollar, which has been declining since last Friday. On Wednesday, the dollar remained in limbo, as the fate of the US Senate hangs in the balance. So far, the election results are close, but US high inflation and fuel costs have weighed the Democratic party down. Concerns that the Democratic party might lose control of Congress in the mid-term elections, leading to political instability in the US, have pushed the dollar down. If the ruling party loses control of Congress, it will not be able to push forward its political and fiscal agenda.

The Fed’s increase in interest rates, however, is attracting investors who seek higher returns boosting the dollar. Fed rhetoric this week remains hawkish, pointing to further rate hikes this year. FOMC member Williams on Wednesday emphasized the need to bring inflation under control, stating that it is currently far above the Fed's long-run goal of 2%.

The US Federal Reserve voted to increase interest rates by 75 basis points at its monetary policy meeting last week. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate in a range of 3.75% to 4.0%. Market expectations are currently in favor of a 50-bps rate hike in December and a 25-bps hike in January. Rate hikes are expected to taper off in 2023 as the central bank moves into a stable interest rate.

US inflation rose by 0.4% every month in September, reaching 8.2% on an annual basis, dropping only slightly from last month’s 8.3%. Price pressures continue to increase in the US, putting extra strain on the Federal Reserve to continue with its policy of monetary tightening. Inflation rates have proved to be resistant to economic tightening and continue to rise. 

Strong volatility in USD price is expected on Thursday as markets will absorb the US election results. In addition, Monthly CPI and Core CPI, as well as Annual CPI data due on Thursday are especially important, as US inflation data may determine the aggressiveness of the US central bank’s future rate hikes. US Monthly CPI for October is expected to be higher than September’s print, but Core CPI, which excludes food and energy, is expected to decline. Hotter than expected inflation print on Thursday is likely to boost the dollar, on increased expectations of future rate hikes.

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EUR 

The Euro retained most of Tuesday’s gains on Wednesday, benefitting from the dollar’s weakness. EUR/USD continued trading above the parity level, dipping slightly at 1.003. If the EUR/USD pair declines, it may find support near the 0.963 level and further down at the 0.953 level representing the 2002 low. If the currency pair goes up, it may encounter further resistance near 1.019.

Uncertainty over the outcome of the US congressional elections has caused the dollar to plummet this week, benefitting competing currencies, such as the Euro. 

ECB rhetoric this week was especially hawkish, raising expectations of future rate hikes. Deutsche Bundesbank Joachim Nagel warned on Tuesday that the ECB needs to continue raising interest rates even if it weighs on the economy. In addition, ECB Vice President Luis De Guindos stated that further rate hikes are needed to combat inflation. 

The Euro exchange rate has been heavily influenced by the dollar’s surge in the past few months, as the US Federal Reserve continues to raise interest rates in an aggressive fight against inflation. The US Fed raised interest rates by 75 bps at its policy meeting last week, bringing its interest rate up to 4.0%. In its latest monetary policy meeting last week, the ECB raised its interest rate by 75 basis points to 1.5%, the highest since 2009. Soaring EU inflation rates are forcing the central bank to hike rates aggressively to reduce price pressures. 

The ECB however, cannot match the Fed’s aggressively hawkish pace, as Eurozone economic outlook is poor, showing signs that the EU is entering a recession. Eurozone's economic outlook is poor, with analysts predicting stagnation later this year and in the first quarter of 2023, limiting the ECB’s ability to raise interest rates. Even though further rate hikes seem certain, the magnitude of the hikes may decrease if the EU shows signs of entering a recession. Preliminary Flash GDP data seem to support this scenario. Flash GDP for the third quarter of 2022 showed economic growth of only 0.2% against an expansion of 0.8% in the previous quarter. Stagflation becomes a real headache for the ECB, which will be forced to battle inflation without the support of a robust economic background.

Record-high Eurozone inflation data indicate that the ECB’s efforts to tackle inflation have not been successful so far. Eurozone inflation in October reached 10.7% versus September’s print of 9.9%. Price pressures continue to increase in the EU, driven primarily by energy prices. 

Several economic activities and health indicators are scheduled to be released Thursday and may affect the Euro considerably. These include the ECB Economic Bulletin and EU Economic Forecasts. The ECB is forced to adjust its monetary policy on a meeting-by-meeting basis, raising interest rates as far as the Eurozone’s fragile economic outlook will allow, and will rely on economic indicators to determine the aggressiveness of its fiscal policy.

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GBP 

The Sterling withdrew on Wednesday, with GBP/USD falling to 1.138. If the GBP/USD rate goes up, it may encounter resistance near 1.149 and higher up at 1.164, while support may be found near 1.125 and further down at the new all-time low of 1.035. 

The dollar’s decline this week has propped up competing currencies. Uncertainty over the results of the US mid-term elections has caused the dollar to retreat sharply. The Sterling, however, is also threatened by political uncertainty in the UK. Political instability has been playing a major part in the currency’s decline over the past few months, driving the pound to an all-time low. 

PM Sunak has vowed that economic stability will be at the heart of his administration’s agenda. Foreign minister James Cleverly has indicated that the much-anticipated new fiscal plan is expected on November 17th and is reported to be a complete reversal of the previous government’s controversial budget. Instead of tax cuts, the current government is likely to go with tax hikes, which will be a tough sell on the British public. 

BOE members voted to increase interest rates by 75 bps last week, matching the Fed’s rate hike. The Fed has so far increased interest rates by a total of 375 basis points this year, bringing its benchmark interest rate up to 4.0%. Currently, the BOE’s interest rate is at 3.0% and the difference with the Fed’s rate is putting pressure on the Sterling. 

In addition, the BOE did not offer specific forward guidance last week, suggesting that future rate hikes may be softer than expected. BOE Governor Andrew Bailey warned that the country is already in recession, which could point to a shift in the BOE’s priorities, from battling inflation to surviving recession. The BOE predicts that the recession could last for almost two years, with expansion not expected again till mid-2024.

The British economy is still struggling and policymakers will have to assess how much tightening it can withstand to bring inflation down. Annual inflation returned to 40-year highs in September, climbing to 10.1%, after cooling to 9.9% in August. Rising UK inflation is forcing the BOE to make some tough choices. 

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JPY

The Yen was strong in early trading on Wednesday but declined later in the day as the dollar started to recover. As the votes for the US mid-term elections are tallied, uncertainty keeps the dollar low, benefitting competing currencies. The USD/JPY rate climbed again on Wednesday, reaching the 146 level. If the USD/JPY pair falls, support might be found near 145 and further down at 143.5. If the pair climbs, it may find resistance at 149.5, further up at 151.9, and higher still at the 1990 high near 160.

The dollar’s collapse this week has benefitted the Yen, which edged higher, boosted by positive economic data for Japan on Wednesday. Annual bank lending in Japan rose to 2.7% in October, against 2.3% in September, exceeding expectations of 2.5%. The current account in September, which provides a measure of the currency’s appeal, climbed to 0.67T from 0.10 T in August, against expectations of 0.01T. Economy Watchers Sentiment released on Wednesday printed at 49.9 in October, climbing from 48.4 in September. Wednesday’s values were just below expectations of 50.0, which is the value above which economic sentiment turns positive.

The release of the BOJ Summary of Opinions on Tuesday also bolstered the Yen. The report is based on the latest BOJ policy meeting ad was more hawkish than expected. BOJ members reaffirmed their commitment to the bank’s ultra-easy policy for the time being. Rising inflation in Japan, however, led to a debate on a future exit from the central bank’s dovish policy. The BOJ revised core CPI projections for 2022 to 2.9% from 2.3% previously, as recent inflation data in Japan exceeded expectations. 

In its latest policy meeting, the BOJ left its monetary policy unchanged, as expected. The BOJ maintained its ultra-easy monetary policy keeping its main refinancing rate at -0.10%. Japan continues to pour money into the economy, while other countries are adopting a tighter fiscal policy. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down. 

Japanese authorities recently staged interventions to support the collapsing Yen, as evidenced by the currency’s sudden surges. The USD/JPY had moved well above the psychological level of 150 when it plummeted suddenly in what was undoubtedly large-scale selling of dollars and buying Yen. The suspected interventions failed to stem the tide, however, and the Yen continued to retreat. The Japanese government cannot support the Yen indefinitely, as continuous interventions would not be sustainable. 

The USD/JPY rate is expected to hinge largely on the dollar’s movement this week, although market participants remain wary of further surprise interventions from the government of Japan. The outcome of the US mid-term elections is expected to affect the USD/JPY rate on Thursday as also the release of the highly-anticipated US inflation data.

Several economic activities and health indicators are also due to be released on Thursday for Japan and may affect the Yen's price. These include M2 Money Stock and Preliminary Machine Tool Orders.

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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