Dollar propped up by rising treasury yields

Important calendar events

• GBP: Nationwide HPI
• EUR: Spanish Flash CPI, German Unemployment Change, Italian Monthly Unemployment Rate, Italian Preliminary CPI
• USD: Chicago PMI

USD

The dollar gained strength on Thursday, with the dollar index rising to the 101.2 level. US treasury yields went up on Thursday, boosting the dollar, with the US 10-year bond yielding approximately 3.84%. 

US Unemployment Claims on Thursday exceeded expectations, putting pressure on the dollar. Unemployment claims reached 218K during the past week, against 211K expected and 206K the week before. Pending Home Sales were also disappointing, reaching stagnation in November versus an expected growth of 0.8%. 

The dollar is under pressure, as the Federal Reserve has completed its hiking cycle. The Fed kept interest rates unchanged at its December meeting, within a target range of 5.25% to 5.50%. 

The Federal Reserve kept its policy settings unchanged at its latest meeting in December but showed signs of a dovish pivot. The FOMC statement emphasized that inflationary pressures in the US are easing, while economic growth remains limited. The Fed’s forward guidance was more dovish than expected, hinting that the central bank is preparing to pivot to a less restrictive monetary policy. 

The Fed’s latest dot plot, which shows policymakers' future interest rate estimates, projects 75 base points of rate cuts within 2024 and 250 basis points by the end of 2026. Market expectations of future rate cuts are driving the dollar down, as markets are currently pricing in a 25 bp rate cut in March with over 70% probability.

The Fed’s hawkish stance over the past year has been paying off and US price pressures are cooling. Headline inflation rose by 3.1% year-on-year in November easing slightly from a 3.2% print in October. CPI rose by only 0.1% in November, while Core CPI, which excludes food and energy, rose by 0.3%. 

US Final GDP data showed that the US economy expanded by 4.9% in the third quarter of 2023. The US economy continues to expand, although growth was more modest than anticipated in Q3. Low economic growth may induce the Federal Reserve to pivot to a less restrictive monetary policy. Final GDP Price Index for the first quarter of the year was also revised lower, with a final print of 3.3% versus 3.6%. This is an indicator of inflation, and a lower print indicates cooling price pressures in the US.

Core PCE price index rose by only 0.1% in November from a 0.2% growth in October against a 0.2% growth expected, bringing the annual rate to 3.2% from 3.4%. This is the Federal Reserve’s preferred inflation gauge and November’s print confirms that price pressures in the US are easing.

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EUR 

EUR/USD dipped on Thursday, dropping to the 1.106 level as the dollar rallied. If the EUR/USD pair declines, it may find support at 1.100, while resistance may be encountered near 1.150. 

Economic activity data released this week for the Euro Area were overall positive, boosting the Euro. Spanish retail sales rose 5.2% in November from a year earlier after rising by a revised 5.3% in October.

ECB policymakers voted to keep interest rates unchanged at 4.50% in December. The ECB seems to have reached its rate ceiling, as the fragile Eurozone economy cannot withstand further tightening. Markets are starting to price in rate cuts in March, although ECB officials have stressed that discussions on a rate cut timeline have not started yet. 

The ECB’s policy is starting to diverge from that of the Federal Reserve. At its latest policy meeting last week, the Fed signaled that interest rates would go down in 2024. ECB President Christine Lagarde, however, has stated that it is too early to talk about rate cuts. Lagarde stressed that interest rates will remain at sufficiently restrictive levels for as long as necessary to bring inflation back to the ECB’s 2% target.

The economic outlook of the Eurozone is deteriorating, however, and may force the ECB to pivot to a more dovish policy. The Eurozone economy does not show signs of recovery and is on the brink of recession. Revised GDP for the Euro area showed that the Eurozone economy contracted by 0.1% in the third quarter of the year, which was in line with expectations. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. Year-on-year the EU economy registered stagnation with GDP flat at 0%. The Eurozone economy is struggling and cannot withstand much further tightening. 

The ECB’s efforts to curb inflation rates are paying off, even at the cost of decreased economic growth. Price pressures in the EU are cooling and this will likely play a decisive role in the ECB’s future policy. Last week the ECB downgraded its inflation forecasts for 2023 and beyond.

Final EU CPI data showed that headline inflation in the Eurozone dropped to 2.4% year-on-year in November, its lowest level since July 2021, from 2.9% in October. Final Core CPI, which excludes food and energy, eased to 3.6% year-on-year in November from 4.2% in October. 

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GBP 

GBP/USD edged lower on Thursday, dropping to the 1.273 level. If the GBP/USD rate goes up, it may encounter resistance near 1.290, while support may be found near 1.261. 

British Finance Minister Jeremy Hunt announced on Wednesday that he will present the spring budget on March 6th, raising expectations about potential tax cuts in the UK. 

British inflation cooled more than expected in November, dropping to 2-year lows. Headline inflation slowed to 3.9% year-on-year in November, from 4.6% in October against expectations of a 4.4% print. Annual Core CPI, which excludes food and energy, grew by only 5.1% in November versus 5.7% in October and 5.6% forecast. 

Inflation in the UK has been resisting the BOE’s efforts to bring it down for a long time but has been dropping at a rapid pace since October. Signs of easing inflationary pressures in the UK are reinforcing expectations that the Bank of England will end its hiking cycle and will be cutting interest rates by mid-2024. 

The BOE maintained its official rate at 5.25% at its latest policy meeting, which was in line with expectations. The central bank’s outlook remains hawkish, however, with three policy members voting to increase interest rates versus six members voting to maintain current rates. 

BOE Governor Andrew Bailey has kept his hawkish stance, stressing that inflationary pressures in the UK remain high and that further tightening might be required to bring inflation down to the bank’s 2% target. 

The BOE has likely reached its rate ceiling but will keep interest rates on hold for a long time to bring inflation down. Even though the current restrictive policy is hurting economic growth, the BOE has no choice but to continue its battle against inflation.

Market expectations of the BOE’s future direction reflect the need to keep interest rates in restrictive territory for longer. The BOE policy is starting to diverge from that of the FED, as the Fed has already signaled that rates will be lowered within 2024. Market odds are in favor of Fed rate cuts starting in March. After the release of November’s UK inflation data, odds of BOE rate cuts in May are rising. 

The British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Prolonged tightening has taken its toll on the labor market and other vital economic sectors. Final GDP data revealed that the British economy contracted by 0.1% in the third quarter of 2023, against expectations of stagnation. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter. Monthly GDP data showed that the British economy contracted by 0.3% in October. Economic growth is slowing down in the UK and the country is entering a recession.

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JPY

USD/JPY seesawed on Thursday, testing the 140.9 level support in early trading, before paring the day’s losses and climbing back to the 141.5 level. If the USD/JPY pair declines, it may find support near 140.9. If the pair climbs, it may find resistance near 142.8.

The BOJ has been keeping interest rates negative, putting pressure on the Yen. The BOJ kept its policy settings unchanged at its December meeting. The central bank kept its short rate target steady at -0.10% and its yield curve control unchanged. The BOJ on Wednesday stated that it would reduce the amount of bonds it buys in its regular operations in the January-March quarter.

The BOJ’s forward guidance into 2024 was more dovish than expected, putting pressure on the Yen. In the past few months, BOJ policymakers have hinted that the central bank is preparing to pivot to a less accommodating policy. BOJ Governor Kazuo Ueda, however, delivered a cautious statement after the meeting, indicating that a policy pivot is still far off. Ueda stated that economic growth remains modest and that underlying inflation will gradually increase, but the BOJ requires sustainable, stable inflation before tightening its monetary policy.

The BOJ Summary of Opinions, which includes the BOJ's projection for inflation and economic growth, was released on Wednesday. The report was more dovish than expected, putting pressure on the Yen. Japanese policymakers emphasized the importance of achieving sustainable and stable inflation before raising interest rates. There were some dissenting voices, however, with some BOJ members arguing in favor of normalizing the bank’s monetary policy.

The Fed has signaled a dovish pivot, relieving some of the pressure on the Yen, which has been weakened by the BOJ’s dovish policy. The BOJ has so far maintained its dovish bias, putting more pressure on the Yen as other major central banks, and especially the Fed, have raised interest rates to high levels. 

Final GDP data for the third quarter of the year showed that Japan's economy contracted by 0.5% in the third quarter against earlier estimates of a 0.5% contraction. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking and is on the brink of recession. Final GDP Price Index showed a 5.3% annual expansion in Q2, versus 3.5% the previous quarter. This is a measure of inflation, which shows that inflationary pressures are rising in Japan, increasing the odds of a hawkish shift in the BOJ’s policy. 

Inflation in Japan has remained above the BOJ’s 2% target for more than a year, encouraging the BOJ to tighten its monetary policy. National Core CPI cooled to 2.5% year-on-year in November from 2.9% in October print. BOJ Core CPI dropped to 3.0% year-on-year in October from 3.4% in September, against expectations of a 3.4% print.

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Written by:
Myrsini Giannouli

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