Euro slips as dollar rallies

Important calendar events

• EUR: Spanish, French, German, and Italian Manufacturing PMI, Eurozone Final Manufacturing PMI, ECB President Lagarde's speech
• Final Manufacturing PMI, ISM Manufacturing PMI, JOLTS Job Openings, FOMC Member Williams and Bullard Speeches

USD

The dollar has been slipping for the past couple of weeks, with the dollar index retreating to 101.3 on Monday. The dollar rallied on Tuesday though and the dollar index climbed above 102%. Bond yields also firmed on Tuesday, with the US 10-year treasury note yielding above 2.8%.

The dollar has been retreating for the past couple of weeks, pushed down by a mix of negative US economic data and unstable market sentiment. The USD had been trading in overbought territory and its high price has tempted traders to close long positions, realizing their profits. 

This week though, the dollar is regaining its strength, supported by robust US economic data. On Tuesday, Consumer Confidence slipped concerning last month, but fell less than expected, boosting the dollar. Other US economic data released on Tuesday were mostly positive, showing that the US economy, showing economic growth. 

The dollar has been boosted by hawkish Fed policy for the past couple of months. In its latest monetary policy meeting, the US Federal Reserve raised its benchmark interest rate by 50 base points to 1%. 

Fed rhetoric has become more cautious though, as inflation woes were balanced out by recession fears. FOMC members point to a series of rate hikes of 50 base points each, confirming that the Fed intends to move with a gradual but steady pace towards monetary policy normalization. On Monday, Fed Governor Christopher Waller stated that the Fed should raise its interest rate by 50 base points at every meeting from now on to tackle soaring inflation in the US. 

Continued Russian hostilities against Ukraine have increased risk-aversion sentiment, providing support for the safe-haven dollar. As there is still no end in sight for crisis, the dollar’s appeal as an investment remains high, although risk appetite seems to be gradually returning to markets. 

Manufacturing PMI data are scheduled to be released on Wednesday, which are important indicators of economic health. In addition, JOLTS Job Openings employment data are scheduled to be released on Wednesday and may affect the dollar. FOMC members' speeches may also cause some volatility in the dollar on Wednesday, as the Fed now seems to be moving at a more conservative pace, halting the currency’s rally.

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EUR

The Euro had been gaining strength over the past couple of weeks, benefitting from the dollar’s weakness. On Tuesday however, the dollar strengthened, while the Euro slipped. The EUR/USD rate fell below 1.070 on Tuesday, before paring some of its losses. If the currency pair goes up, it may encounter resistance at 1.093. If the currency pair falls, it may encounter support at the 1.036 level which represents the 2016 low, and further down near a 20-year low of 0.985.

The dollar’s rally pushed the Euro down on Tuesday. Several economic indicators released on Tuesday were also negative for the state of the EU economy, dragging the currency down. CPI estimates, which are leading indicators of consumer inflation, were also released on Tuesday and showed that EU inflation is on the rise. Inflation in the Eurozone climbed to record highs, reaching 8.1% in May, driven by rising food and energy costs. In addition, EU members have finally reached an agreement on banning Russian oil imports. Concerns about rising energy costs in the EU are driving the Euro down.

The Euro has been regaining some of its lost ground against the dollar, as ECB and Fed policies seem to be converging gradually. The ECB has been hinting heavily at a July rate hike, while the Fed grows hesitant about moving forward with a more aggressive monetary policy. Rising inflation rates in the EU increase the chances that the ECB will go forward with a rate hike in July. The Eurozone economy, however, is still trying to recover from the pandemic and recession fears are growing in the EU. 

Clear indications from the ECB that it would move towards a more hawkish policy this year, have boosted the Euro. Markets are now pricing in up to 105 base points rate hikes throughout the year. ECB President Christine Lagarde has pointed to rate hikes in Q3 of this year, which would bring the ECB’s interest rate at least to zero and possibly to positive territory. ECB members are starting to agree on a more hawkish policy starting in the third quarter of the year and the consensus between them seems to be that the ECB will perform its first rate hike in decades at its next policy meeting in July. 

Manufacturing PMI data are scheduled to be released on Wednesday for some of the Eurozone’s leading economies and the Eurozone as a whole. PMI data are important indicators of economic health and may have a strong impact on the Euro. In addition, ECB President Christine Lagarde is due to deliver a speech at a conference on Wednesday and her speech will be scanned by market participants for insight into the ECB’s monetary policy. 

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GBP 

The sterling fell on Tuesday on week economic data, while the dollar recovered. GBP/USD plummeted early on Tuesday falling to 1.255, before paring its losses later in the day. If the GBP/USD rate goes up, it may encounter resistance near the 1.308 level, while if it declines, support may be found near the two-year low at 1.206. 

In the past couple of weeks, the sterling had been supported by a weakening dollar. As risk-aversion sentiment remains high though, the sterling’s advance is halted. On Tuesday, the dollar rallied, while the pound fell. Several indicators were released on Tuesday, showing the British economy is still sluggish. Consumer spending and confidence are declining, driving the sterling down.

The sterling has been losing ground against the dollar due to the divergence in monetary policy between the Fed and the BOE. Although the BOE started the year with a strong hawkish policy, it has recently backed down and moderated its stance, weighted down by the still fragile British economy. In its latest monetary policy meeting, the Bank of England raised its benchmark interest rate by 25 base points, bringing its rate to a 13-year high of 1%. 

Headline inflation in the UK rose to 9% in April, while core inflation hit 6.2%. Headline inflation reached a new 40-year high, highlighting the need for legislative action to tame soaring inflation rates. The cost of living in the UK has been increasing, driven primarily by the high cost of energy imports, putting pressure on UK households. Stagflation is a risk for the UK economy, as for many other countries, as economic stagnation coupled with rising inflation creates a toxic mix for the economy.

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JPY

The Yen plummeted this week, with the USD/JPY pair climbing above 128.8 on Tuesday. If USD/JPY rises, it may find resistance at 129.7 and further up at 131.35. If the USD/JPY declines, support might be found near the 127 level and further down at the 121.3 level. 

The Yen slipped on Tuesday, while the dollar rallied, pushing the USD/JPY rate up. Economic data released on Tuesday for Japan were mixed, failing to provide support for the currency.

Bond yields have fallen across Japan’s treasury curve due to low demand. Japan’s 10-year government bond yields approximately 0.24% interest rate as the BOJ continues to buy an unlimited amount of Japanese treasury bonds, defending their current low yield.  In contrast, the respective US 10-year bond is offered with a yield of approximately 2.8%, more than an order of magnitude higher than the Japanese bond. The large divergence in bond yields makes the low-yielding Yen less appealing to investors than the dollar, pushing its price further down.

The primary driver of the Yen over the past few months has been the BOJ’s fiscal policy, with the BOJ following an ultra-easy monetary policy to support the struggling economy. While other countries are moving towards quantitative tightening to return to pre-pandemic fiscal policies, Japan continues to pour money into the economy and maintains its negative interest rate. The difference in interest rates with other major Central Banks, especially with the Fed, puts the Yen at a disadvantage, driving its price down.

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Written by:
Myrsini Giannouli

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