Weak US Services data drive the dollar down

Important calendar events

• EUR: Spanish, Italian, French, and German Final Services PMI, EU Final Services PMI, PPI, ECB Monetary Policy Meeting Accounts
• GBP: Final Services PMI, Housing Equity Withdrawal
• USD: Challenger Job Cuts, Unemployment Claims, Trade Balance

USD

The dollar continued to decline on Wednesday, with the dollar index dropping below the 104.3 level. US treasury yields remained firm, with the US 10-year bond yielding approximately 4.36%. 

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 aligned 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 cut 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 on the timeline of the Fed’s pivot to a more dovish policy. Fed Chair Jerome Powell has 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. 

On the data front, US Services data released on Wednesday were disappointing, driving the dollar down. ISM Services PMI data showed that US services sector activity has slowed down. The ISM index dropped to 51.4 in March from 52.6 in February, missing expectations of a 52.8 print. March’s print remained above the value of 50, indicating that the service sector continues to expand, but expansion has decelerated. ADP Non-Farm Employment Change data on Wednesday were optimistic, showing that 184K new workers were added to the US workforce in March against expectations of 148K.  

JOLTS job openings released on Tuesday were in line with expectations. The US economy added 8.76M new jobs in February after adding 8.75M jobs in January. US manufacturing data on Monday exceeded expectations, boosting the dollar. The ISM Manufacturing PMI index rose rapidly in March, with a print above zero, which is the threshold for sector expansion. March’s print of 50.3 far exceeded February’s value of 47.8 as well as expectations of just 48.5, indicating that the US manufacturing sector is growing at a rapid pace. ISM Manufacturing prices also rose in March, with a print of 55.8 against expectations of 53.3. This is also a measure of consumer inflation and a print above 50 denotes rising manufacturing prices.

The US economy remains robust and expanded by 3.4% in the final quarter of 2023, exceeding previous estimates of 3.2% growth. The US economy is expanding at a slower pace, however, as GDP data have shown expansion by 4.9% in the third quarter of 2023.

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. 

Core PCE Price Index, which is the Fed’s preferred inflation gauge, rose by 0.3% in February compared to January’s 0.4% growth, which was in line with expectations.  On an annual basis, Core PCE dropped just below 2.8% in February, registering a marginal drop from January’s almost 2.9% print. Core PCE Price Index data showed that US disinflation is progressing, albeit slowly. 

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EUR 

EUR/USD surged to 1.084 on Wednesday, boosted by optimistic Eurozone inflation data. If the EUR/USD pair declines, it may find support at 1.069, while resistance may be encountered near 1.086.

The Euro gained strength against the dollar on Wednesday, as EU CPI data showed that disinflation in the Eurozone is well underway. Headline inflation in the Euro area cooled to 2.4% in March from 2.6% in February against expectations of a 2.5% print. Core CPI, which excludes food and energy, dropped to 2.9% from 3.1% the previous month, versus 3.0% anticipated. Easing price pressures in the Eurozone may encourage the ECB to start lowering borrowing costs as early as June.

German inflation data on Tuesday showed that inflationary pressures in the Euro area’s largest economy are cooling. German CPI rose by only 0.4% in March according to preliminary estimates against the 0.5% growth forecasted. Manufacturing PMI data for some of the Eurozone’s leading economies and the EU as a whole were also optimistic. EU Manufacturing PMI rose to 46.1 in March from 45.7 in February against expectations of a 45.7 print. The EU manufacturing sector remains in contractionary territory as denoted by a print below 50 but the sector’s contraction is slowing down.

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. 

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 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. Market odds of a rate cut in June are at approximately 60%, while most market analysts forecast around 90 basis points of cuts this year. 

ECB policymakers were dovish last week, expressing satisfaction at the rate of disinflation in the Eurozone and raising expectations of rate cuts in the following months. Markets are pricing in a rate cut in June with high probability and approximately 100 basis points of rate cuts are expected within the year.

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GBP 

The GBP/USD rate skyrocketed to the 1.265 level on Wednesday as the dollar plummeted. If the GBP/USD rate goes up, it may encounter resistance near 1.266, while support may be found near 1.251. 

Final British Manufacturing PMI data on Tuesday surprised on the upside boosting the Sterling. The British Manufacturing sector finally moved away from the contractionary area and started to expand. UK Manufacturing PMI rose to 50.3 in March from 47.8 in February against expectations of 49.9. A print above 50 denotes industry expansion and this was the first month since September 2022 that the British manufacturing sector registered expansion. 

The BOE maintained its official rate at 5.25% at its policy meeting in March 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, stating that cooling inflationary pressures in the UK support potential interest rate cuts and hinting at two or three rate cuts within the year.

Markets are pricing in the first BOE rate cut in June with approximately 60% probability, while a rate cut by 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 this 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. 

Recent GDP data showed that the British economy has slipped into recession. Final GDP data confirmed previous estimates that the British economy contracted by 0.3% in the final quarter of 2023. The British economy is fragile and may force the BOE to pivot to a more dovish policy.

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JPY

USD/JPY surged above the key 151.9 level in early trading on Wednesday, then retreated to 151.6 as the dollar weakened. If the USD/JPY pair declines, it may find support near 151.0. If the pair climbs, it may find resistance near 151.9.

The Yen touched a 34-year-low against the dollar last Wednesday, with USD/JPY trading close to the key 152 level. Yen intervention concerns are high, as Japanese authorities have been warning repeatedly that an intervention to support the currency might be imminent. 

The Yen’s weakness is causing concern to Japanese officials who have been warning traders against speculative short selling of the Yen. Finance Minister Shunichi Suzuki stated on Monday that the Japanese government does not rule out any options against excessive currency movement and is ready to take action to support the currency. Suzuki and other Japanese officials have been issuing warnings to currency speculators repeatedly in the past couple of weeks, hinting at another intervention to support the weakening Yen. Japanese Finance Minister Shunichi Suzuki reiterated his previous statement on Tuesday, that authorities were ready to take appropriate action against excessive exchange-rate volatility.

Japanese authorities have intervened to support the currency in the past and may do so again if the Yen continues to decline. Concerns about an imminent intervention have been keeping Yen short sellers in check, providing some support for the currency.

The BOJ pivoted to a more hawkish policy in March, 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, stating that accommodative financial conditions will be maintained for the time being and did not give any hints of future rate hikes. In addition, Japanese policymakers are concerned about inflation not rising according to expectations. The BOJ’s 2% inflation target has not been met sustainably yet, 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. 

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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