Important calendar events
The dollar edged higher on Tuesday, with the index touching the 106.4 level. US treasury yields also rose on diminishing Fed rate cut expectations, with the US 10-year bond yielding approximately 4.67%.
Increased demand for safe-haven assets due to rising tensions in the Middle East is boosting the dollar. The conflict between Israel and Iran is escalating and is expected to influence Forex markets this week. Tensions in the Middle East have been high after the recent airstrike on Iran’s embassy in Syria. Iran accused Israel of the attack and launched a retaliative drone strike on Israeli ground over the weekend. The US has pledged to support Israel in the conflict, raising concerns of a wider regional conflict.
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. The FOMC statement was optimistic about the state of the US economy and emphasized that disinflation is underway, although inflationary pressures remain high.
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 policymakers wish to see more evidence of disinflation before cutting interest rates. The Fed is carefully monitoring the progress of disinflation in the US, which is linked with the central bank’s monetary policy.
US inflation surprised on the upside last week boosting the dollar. US Headline inflation rose by 3.5% year-on-year in March exceeding February’s 3.2% print and rising above expectations of a 3.4% print. Monthly CPI rose by 0.4% in March, against expectations of 0.3% growth. Inflation in the US has proven to be sticky, resisting the Federal Reserve’s efforts to bring it down to its 2% target.
Speaking at a forum in Washington on Tuesday, Powell stated that the progress of disinflation is slower than originally anticipated and will likely affect the timeline of Fed rate cuts. Fed rate cut odds dropped further after Powell’s speech and US treasury yields surged, boosting the dollar.
Market expectations of rate cuts have shifted repeatedly in the past few months. At the beginning of the year, the first rate cut was expected in March, but currently, market odds of a rate cut in July have dropped below 50%. More importantly, a few months ago markets were pricing in over 100 basis points of rate cuts in 2024 markets, which have now dropped to 50 basis points. Market expectations of rate cuts are becoming more moderate as policymakers have stated that they intend to start reducing interest rates slowly. Diminishing rate cut expectations are boosting US treasury yields, providing support for the dollar.
On the data front, housing data released on Tuesday were disappointing. Building permits in the US dropped to 1.46M in March from 1.52M in February, falling short of expectations of 1.51M. This is an indicator of future building activity and March’s data show that the US housing sector is shrinking. In addition, US Housing Starts, which shows the number of new residential buildings that began construction, also fell below expectations. Housing starts dropped to 1.32M in March from 1.55M in February, versus 1.48M expected.
Retail Sales rose by 0.7% in March against expectations of a 0.4% growth according to data released on Monday. Moreover, February’s print was revised upwards to reflect a monthly growth of 0.9%. Core Retail Sales, which exclude the sales of automobiles, rose by 1.1% in March exceeding expectations of 0.5%, and February’s Core Retail sales were also revised upwards to 0.6%.
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.
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.
EUR/USD traded sideways on Tuesday, oscillating around the 1.062 level. If the EUR/USD pair declines, it may find support at 1.045, while resistance may be encountered near 1.088.
Robust economic activity data for the Eurozone propped up the Euro sufficiently to counterbalance the dollar’s advance on Tuesday. German investor morale reached its highest level in two years, as evidenced by the German ZEW Economic Sentiment Index. The index surged to 42.9 in April from 31.7 in March exceeding expectations of 35.9. ZEW Economic Sentiment for the entire Euro Area also exceeded expectations, rising to 43.9 in April from 33.5 in March against expectations of a 37.8 print.
The ECB left all policy settings unchanged at its monetary policy meeting last week. The European Central Bank kept interest rates unchanged at 4.50% but hinted at a dovish shift in the future. In their statement after the meeting, policymakers stressed that if Euro area inflation remains on a path to achieve the central bank’s 2% target, it would be appropriate to reduce the current level of monetary policy restriction.
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.
The ECB is expected to start cutting interest rates later this year since inflationary pressures in the Euro area are easing. ECB President Christine Lagarde stated that ECB policymakers wish to see more evidence of inflation dropping to the central bank’s 2% target before cutting interest rates. Lagarde hinted 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 rose after the ECB meeting, while most market analysts forecast around 75 basis points of cuts this year.
The Euro is under pressure by expectations that the ECB will start lowering interest rates by June. The Fed is not likely to start cutting interest rates before July, putting the Euro at a disadvantage against the dollar. In addition, markets are currently pricing in only 50 basis points of Fed rate cuts within 2024, compared to 75 bps of ECB rate cuts.
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.
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. The 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.
GBP/USD traded close to a five-month low on Tuesday, dropping to the 1.242 level. If the GBP/USD rate goes up, it may encounter resistance near 1.271, while support may be found near 1.237.
Weak UK labor data on Tuesday put pressure on the Sterling. The UK unemployment rate in the three months to February rose to 4.2% from 3.9% the previous month, against expectations of a 4.0% print. For the same period, the Average Earnings Index grew by 5.6%, which was unchanged from last month’s reading, exceeding expectations of 5.5% growth. Claimant Count Change, which reflects the change in the number of people claiming unemployment benefits, rose to 10.9K in March from 4.1K in February, falling, however, short of the 17.2K print anticipated.
The BOE maintained its official rate at 5.25% at its policy meeting in March but showed signs of preparing for a dovish pivot. 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 50% 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 50 basis points of rate cuts expected 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 the 4.6% forecast. British CPI data on Wednesday are expected to show that UK inflation cooled to 3.1% in March, dropping closer to the BOE’s 2% target.
The British economy slipped into recession last year, contracting by 0.3% in the final quarter of 2023. Monthly GDP data for February released last week, however, revealed that the British economy has narrowly avoided slipping into recession and has expanded by 0.1%. More importantly, January’s GDP was revised upwards to show an expansion of 0.3%. The British economy is fragile and may force the BOE to pivot to a more dovish policy.
USD/JPY skyrocketed to its highest level since May 1990 this week, touching the 154.7 level on Tuesday. The currency rate is approaching the key 155.0 level, which some analysts identify as the point for intervention in support of the Yen. If the USD/JPY pair declines, it may find support near 151.3. If the pair climbs, it may find resistance near the psychological level of 155 and above that at a multi-decade high of 160.5.
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 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. Suzuki stated on Monday that Japanese authorities were watching currency moves closely, and that they were fully prepared to act. Suzuki reiterated on Tuesday that the Japanese government will take a thorough response as needed.
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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