Yen plummets even after BOJ raises interest rates

Important calendar events

• EUR: German PPI, Italian Industrial Production, Consumer Confidence
• GBP: CPI and Core CPI, PPI Input and Output, RPI, HPI
• USD: Federal Funds Rate, FOMC Economic Projections, FOMC Statement, FOMC Press Conference

USD

The dollar gained strength on Tuesday, with the dollar index climbing above the 103.8 level. US treasury yields remained steady, with the US 10-year bond yielding approximately 4.30%. 

The Fed’s policy meeting on Wednesday will be the highlight of this week. 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 has removed the tightening bias from its policy statement, indicating that the central bank is preparing to pivot to a less restrictive monetary policy. 

For months now, markets have been speculating as to the timeline of the Fed’s pivot to a more dovish policy. Interest rates are expected to remain unchanged this month and the Fed’s first rate cut is priced in for June. Traders will focus especially on Fed Chair Jerome Powell’s speech after the meeting, to gain insight into the central bank’s policy outlook. 

Fed officials wish to see more evidence of disinflation before moving ahead with cutting interest rates. Odds of a rate cut in March and May are practically nil. Rate cut odds in June are below 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 inflation surprised on the upside last week, boosting the dollar. PPI data released on Thursday showed that price pressures in the US remain sticky and may derail the Fed’s plans of lowering interest rates. PPI rose by 0.6% in February against 0.3% anticipated and a 0.3% print in January. Core PPI, which excludes food and energy, also exceeded expectations, rising by 0.3% versus the 0.2% anticipated, registering a lower monthly growth than January’s 0.5%, though. 

The highly anticipated US CPI data on Tuesday showed an uptick in US inflation in February. February’s inflation was hotter than anticipated and may set back the Fed’s plans to reduce interest rates. 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 0.4% 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. 

Preliminary US GDP data showed that the US economy remains robust and expanded by 3.2% in the final quarter of 2023, missing market forecasts of 3.3%. 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. 

TRADE USD PAIRS

EUR 

EUR/USD weakened on Tuesday, dipping to 1.084 before paring some of the day’s losses. If the EUR/USD pair declines, it may find support at 1.083, while resistance may be encountered near 1.096.

Economic sentiment in the Eurozone is improving, according to data released on Tuesday. The ZEW Economic Sentiment survey gave a reading of 33.5 in March against expectations of 25.4 and a print of 25.0 in February. A value above zero denotes optimism, with March’s report showing increased economic confidence. Economic Sentiment was especially improved in Germany, which is the Euro area’s leading economy. German ZEW Economic Sentiment rose to 31.7, its highest value in over two years, beating market estimates of 20.5.

Final CPI data released on Monday confirmed preliminary data that showed that Eurozone inflation cooled in February. 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%.

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 the ECB wants to see more evidence of inflation dropping to the central bank’s 2% target. Lagarde said that policymakers 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. 

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. 

TRADE EUR PAIRS

GBP 

GBP/USD plummeted to 1.267 in early trading on Tuesday but pared losses later in the day, climbing back to 1.072. If the GBP/USD rate goes up, it may encounter resistance near 1.289, while support may be found near 1.260. 

Several major central banks are holding their monetary policy meetings this week. The BOJ will announce its interest rate decision on the 19th, the US Federal Reserve on the 20th, and the BOE on the 21st. Policy changes are expected in all three central banks later this year, with the BOJ likely to tighten its ultra-loose policy, while the Fed and the BOE will likely move to less restrictive policies.

The BOE maintained its official rate at 5.25% at its latest meeting and updated its inflation outlook, predicting that inflation will drop to the BOE’s 2% target in the second quarter of the year. 

Markets are pricing in the first BOE rate cut in June with approximately 50% 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 within the year. 

British inflation data for February are due on Wednesday, just a day before the BOE monetary policy decision. Headline inflation in the UK is forecast to drop sharply in February and to continue cooling at a fast pace in the following months. 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 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. 

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.

TRADE GBP PAIRS

JPY

The Yen plummeted on Tuesday, even as the BOJ raised interest rates and the USD/JPY rose to the 151 level. If the USD/JPY pair declines, it may find support near 146.5. If the pair climbs, it may find resistance near 151.9.

The BOJ pivoted to a more hawkish policy on Tuesday, 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 on Tuesday. 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. Japanese bond yields declined after the announcement, putting pressure on the Yen.

Markets were pricing in only a 44% chance of a rate hike before the meeting, with higher expectations of ending negative interest rates at the bank’s next meeting in April. Even though the central bank’s move had not been fully priced in and came as a surprise, the Yen went into freefall after the policy meeting.

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.

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. BOJ Core CPI remained at 2.6% year-on-year in January against expectations of 2.3% print. In addition, headline inflation rose by just 2.0% year-on-year in January from 2.3% in December. 

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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