Dollar strong ahead of Fed meeting

Important calendar events

• JPY: Monetary Base, Monetary Policy Meeting Minutes
• EUR: German Trade Balance, French Government Budget Balance, Spanish, French, Italian, and German Manufacturing PMI
• USD: ADP Non-Farm Employment Change, FOMC Statement, Federal Funds Rate, FOMC Press Conference

USD

The dollar withdrew in early trading on Tuesday but rallied later in the day with the dollar index dropping to 110.8 and then climbing back above 111.5. US Treasury yields also slipped in early trading but recovered later in the day, with the US 10-year bond yield rising from 3.94% to 4.06%.

A Fed black-out period started over a week ago, preventing further comments until the central bank’s next policy meeting on Wednesday. The dollar became more vulnerable without the fortifying effect of hawkish Fed speeches and lost ground on renewed risk appetite early on Tuesday. As the much-anticipated Fed meeting is drawing near, however, market confidence in the dollar increases on rate hike expectations. High-risk aversion sentiment has been prevalent throughout the year and is increasing the safe-haven dollar’s appeal. At the same time, the Fed’s increase in interest rates is attracting investors who seek higher returns, boosting the dollar. 

Macroeconomic data released on Tuesday were overall optimistic for the state of the US economy, bolstering the dollar ahead of Wednesday’s Fed meeting. JOLTS Job Openings on Tuesday exceeded expectations, rising to 10.72M in September, versus 10.28M in August and 9.75M expected. Construction Spending in September exceeded expectations, rising by 0.2%, against a contraction of 0.6% the previous month. ISM Manufacturing PMI in October was slightly higher than expected at 50.2 against the 50.0 predicted but was still lower than September’s reading of 50.9. 

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. 

All eyes are going to be on the Fed monetary policy meeting on Wednesday. The US Central Bank has increased interest rates by 300 basis points this year, bringing its benchmark interest rate to 3.25%. Another rate hike of at least 75 bps is expected at Wednesday’s meeting and has already been largely priced in by markets.

Of equal importance to the interest rate announcement are the FOMC Statement and Press Conference following the monetary policy meeting. Market participants will focus on these in an attempt to gauge the central bank’s future policy direction. 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.

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EUR 

The Euro gained strength early on Tuesday as the dollar slipped but pared gains later in the day on a stronger dollar. The Euro continued trading well below parity with the dollar, dropping near 0.987 by the end of the day. 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 resistance at the parity level and higher up near 1.009.

German import prices in September declined by 0.9% against a 4.3% increase in August. This is an indication that price pressures are going down in the EU’s leading economy and may point to cooling inflation in the coming months. 

The Euro has been on the decline since last week’s ECB monetary policy meeting. The ECB raised its interest rate by 75 basis points to 1.5% last week, the highest since 2009. Soaring EU inflation rates are forcing the central bank to hike rates aggressively to reduce price pressures. Markets had already priced in a 75-bp rate hike, however, and the increase in interest rates failed to provide support for the Euro. In addition, the US Fed has a much-larger interest rate of 3.25%, which is expected to reach 4.0% or higher after the US central bank’s policy meeting this week.

The ECB monetary policy statement and press conference following the announcement of the main refinancing rate had bearish undertones, further weakening the Euro. ECB President Christine Lagarde’s speech lacked a forward bias, stating that future rate hikes will be considered on a ‘meeting by meeting’ basis. 

Record-high Eurozone inflation data failed to provide support for the Euro in the wake of the ECB policy meeting. CPI Flash and Core CPI Flash data on Monday far exceeded expectations. Eurozone inflation in October reached 10.7% versus September’s CPI of 9.9%. Price pressures continue to increase in the EU, driven primarily by energy prices. Core CPI, which excludes food and energy, was also up though, reaching 5.0% in October against expectations that it would remain at last month’s level of 4.8%. The ECB will need to continue its aggressive monetary tightening to tame soaring inflation rates.

Eurozone economic outlook however 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 economy cannot withstand aggressive tightening. 

Preliminary Flash GDP data released on Monday seem to support this scenario. Flash GDP for the third quarter of 2022 shows 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.

Manufacturing PMI data for some of the Eurozone’s leading economies are due on Wednesday and may affect the Euro. The EUR/USD rate, however, is expected to hinge primarily on the outcome of Wednesday’s Fed meeting.

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GBP 

The Sterling ended the day lower on Tuesday, despite gaining strength early in the day and GBP/USD dropped to 1.144. 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. 

Renewed risk appetite early on Tuesday boosted the Sterling against the safe-haven dollar. Robust US economic data later in the day though, increased expectations of a steep rate hike on Wednesday, bolstering the dollar.

On the data front, economic activity indicators released on Tuesday for the UK were overall mixed. Monthly HPI in October declined by 0.9% against predictions of a smaller decline of 0.4%. This is the earliest indicator of housing prices and a reduction in this indicator points to declining sector health and may signal the beginning of a property slump. Final Manufacturing PMI on the other hand was up to 46.2 in October from 45.8 in September, indicating an expansion in the Manufacturing sector.

With both the Fed and the BOE monetary policy meetings drawing near, market expectations incline more towards a sharp Fed rate hike, boosting the dollar. The Sterling on the other hand is slipping after a protracted period of political instability. Political instability has been playing a major part in the currency’s decline over the past few weeks, driving the pound to an all-time low. 

PM Sunak vowed last week that economic stability will be at the heart of his administration’s agenda eliciting a positive reaction from markets. Foreign minister James Cleverly has indicated that the much-anticipated new fiscal plan, which had been scheduled for October 31, may be delayed as the government would need more time to draft a solid budget. Repairing the country’s finances is bound to be a difficult task for the new government. The new fiscal statement 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. 

The BOE has also announced a new round of bond buying. The British central bank will hold 8 bond sales Between November 1st and the end of the year, which will be evenly distributed across the short and medium-maturity sectors only in the 4th quarter of 2022. 

This week, the much-anticipated BOE policy meeting is scheduled for Thursday, November 3rd. Coming a day after the Fed monetary policy meeting, the BOE meeting is likely to generate high volatility for the Sterling and the combined events may provide direction for GBP/USD.

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. The Bank of England raised its interest rate by 50 bps in its latest meeting, bringing the total interest rate to 2.25%. The BOE adopted a moderate stance, trying to strike a balance between battling inflation and supporting the sluggish economy. 

Markets are expecting a shift towards a more aggressively hawkish policy after September’s inflation report, with odds in favor of a 75-bps increase. A 75-bps rate hike has already been priced in and will likely not affect Sterling's price significantly. Market participants will follow the Monetary Policy Summary and BOE Governor Andrew Bailey’s speech closely, for hints into the central bank’s future policy direction.

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JPY

The Yen exhibited high volatility on Tuesday, gaining strength early in the day but declining later on. USD/JPY dropped to the 147 level in early trading, then crossed the resistance near 147.7, climbing above 148.2. 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 further up at the psychological level of 150 and higher still at the 1990 high near 160.

Final Manufacturing PMI data released on Tuesday for Japan were in line with expectations and did not affect the currency significantly. Manufacturing PMI in October was 50.7, the same as in September and exactly as predicted, indicating that the manufacturing sector in Japan is stable.

Japanese authorities likely staged interventions over the past week to support the collapsing Yen, as evidenced by the currency’s sudden surges. The USD/JPY Yen had moved well above the psychological level of 150 the week before, but 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 BOJ policy meeting last week held few surprises, as 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 puts the Yen at a disadvantage, driving its price down. BOJ Governor Haruhiko Kuroda remained firm in his dovish stance though, even as the weakening Yen caused anxiety among government officials.

The BoJ revised core CPI projections for 2022 to 2.9% from 2.3% previously, as recent inflation data in Japan exceeded expectations. The central bank also kept its 10-year Japanese Government Bond yield target at plus or minus 25 basis points around 0.00%. With the corresponding US bonds yielding above 4.0%, the difference in bond yields is putting pressure on the Yen. 

Japan’s Prime Minister Fumio Kishida announced last week an extra 29.1 Trillion Yen in budget stimulus measures that include steps to curb electricity bills, which could tame inflation. 

With the Fed interest rate decision on the horizon, the USD/JPY rate is expected to depend primarily on the result of the Fed meeting, although market participants remain wary of further surprise interventions from the government of Japan.

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Written by:
Myrsini Giannouli

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