The dollar slides ahead of a key Congress vote

Important calendar events

• JPY: Preliminary Industrial Production, Retail Sales, Consumer Confidence, Housing Starts
• GBP: BRC Shop Price Index, MPC Member Mann Speaks
• EUR: German, Italian, and French Preliminary CPI, French Consumer Spending, French Preliminary GDP, German Unemployment Change, ECB Financial Stability Review
• USD: JOLTS Job Openings, FOMC Member Harker and Bowman Speeches, Beige Book

USD

The dollar slipped on Tuesday, with the dollar index dropping below 104.1. US Treasury yields also retreated, with the US 10-year bond yield dropping from 3.76% to 3.69%. 

Concerns of a potential US debt default have been causing economic uncertainty, affecting dollar prices. US Treasury Secretary Janet Yellen has warned that the office would not meet all US government obligations by June 5th. This would force the country to default on its debt, leading to a major recession. 

US President Joe Biden and Republican House Speaker Kevin McCarthy have been negotiating a deal that would raise the government's debt limit, preventing the US from going into default. Talks between the Democrats and the Republicans pushed into the weekend and the two parties announced that they have reached a tentative agreement to suspend the federal government's $31.4 trillion debt ceiling. The deal, however, will have to be approved by Congress before the US runs out of resources to meet its obligations. The deal to increase the debt ceiling will be presented to the US Congress on Wednesday. US lawmakers will be called to assess the deal with little time to spare.

The dollar soared last week on upbeat US economic data. GDP data released last week showed that the US economy expanded by 1.3% in the first year of 2023 against predictions of a 1.1% growth. The preliminary GDP Price Index, which is an important inflation gauge, also exceeded expectations, rising by 4.2% in Q1 of 2023 versus the 4.0% anticipated. US Unemployment claims dropped to 229K last week, against more pessimistic estimates of 249K.

US Federal Reserve Chair Jerome Powell has indicated that the US Central Bank may pivot towards a more dovish direction. The Federal Reserve raised interest rates by 25 basis points at its latest monetary policy meeting, bringing the benchmark interest rate to a 16-year high target range of 5.00% to 5.25%. 

Markets anticipate a pause in rate hikes in June. The US Central Bank has signaled that its hawkish policy is coming to an end, as prolonged tightening is putting the economy at risk and the recent turmoil in the banking sector has increased recession concerns. Many analysts predict that there is a high probability of rate cuts starting in November, depending on economic conditions and inflationary pressures. 

US Headline inflation dropped to 4.9% year-on-year in April, decelerating from a 5.0% print in March. US Inflation cooled more than expected in April, as markets were anticipating a 5.0% print. 

US Core PCE Price Index, however, rose 0.4% on a monthly basis in April versus a forecast of 0.3%. Core PCE, which is the Fed’s primary inflation gauge, went up by 4.7% year-on-year in April, having gained by 4.6% in March. Inflationary pressures in the US remain sticky, suggesting that the Fed may have to persist on its policy of monetary tightening to restore price stability.

Advance GDP data for the first quarter of the year showed that the US economy expanded by 1.1% against expectations of 2% and a 2.6% growth in Q4 of 2022. Advance GDP Price Index on the other hand rose by 4.0% in Q1 of 2023, versus 3.7% expected. This index is a measure of inflation and indicates that price pressures remain high. 

JOLTS job openings on Wednesday are important to labor data and may affect the dollar. In addition, several FOMC members are due to deliver speeches on Wednesday. These may cause volatility in dollar prices, as traders are trying to gauge the Fed’s future policy direction.

TRADE USD PAIRS

EUR 

EUR/USD was volatile on Tuesday, testing the 1.070 level support in early trading, before climbing back to the 1.074 level. If the currency pair goes up, it may encounter resistance near 1.083. If the EUR/USD pair declines, it may find support at 1.070. 

Economic activity indicators released on Tuesday for some of the Eurozone’s leading economies were overall disappointing, putting pressure on the Euro. EU Private Loans increased by 2.5% in April from 2.9% in March, against expectations of a 2.7% growth. In addition, Spain’s headline inflation dropped to 3.2% year-on-year in May from 4.1% in April. 

The ECB raised interest rates by 25 bp at its latest monetary policy meeting, bringing its main refinancing rate to 3.75%. The ECB had raised interest rates by 50 bp in previous meetings and is slowing down the pace of rate hikes. 

The ECB has left the door open for further rate hikes as inflationary pressures in the EU remain high. The ECB, however, is expected to reassess its policy direction ahead of its next meeting in June. EU policymakers must take a lot of variables into account, including the effect of economic tightening on the now fragile banking sector. 

ECB President Christine Lagarde has stated that the ECB is approaching a key juncture and that further action is necessary to bring inflation down to the bank’s 2% goal. Lagarde’s comments point to further rate hikes up ahead, while the US Fed has signaled a pause in rate hikes.

Price pressures in the Eurozone remain high. Headline inflation rose to 7.0% year-on-year in April from 6.9% in March, in line with expectations. Core CPI, which excludes food and energy, dropped slightly to 5.6% on an annual basis in April from 5.7% in March. Eurozone inflation is not showing signs of cooling despite the ECB’s aggressive tightening. 

GDP Flash data for the first quarter of the year showed that the Eurozone economy expanded by 0.1%, registering a small improvement against the 0 print for the final quarter of 2022. 

TRADE EUR PAIRS

GBP 

The Sterling gained strength against the dollar on Tuesday and the GBP/USD pair climbed to the 1.244 level. If the GBP/USD rate goes up, it may encounter resistance near 1.248, while support may be found near 1.230. 

Headline inflation in the UK dropped below 10% on an annual basis in April for the first time since August 2022. CPI data released last week revealed that inflation in the UK is starting to cool, although not as rapidly as anticipated. Headline inflation rose 8.7% year-on-year in April from 10.1% in March, surpassing expectations of 8.2%. Core CPI, which excludes food and energy, however, rose to 6.8% on an annual basis in April from 6.2% in March.

BOE governor Andrew Bailey has warned that inflation in the UK is persistent and will require further tightening to bring inflation to target. The BOE raised interest rates by 25 basis points at its latest meeting in May, bringing the bank rate to 4.5%. Market odds are in favor of more BOE rate hikes up ahead and many analysts predict no rate cuts at all within the year. The BOE has been following an aggressively hawkish monetary policy, aiming to bring inflation down. 

The British economy contracted by 0.3% in April, after registering stagnation in March. The International Monetary Fund, however, upgraded the UK’s growth prospects stating that a recession was now unlikely. The IMF had previously forecasted that the British economy will contract by 0.6% this year. 

The UK’s weak economic outlook limits policymakers’ ability to increase interest rates sufficiently to rein in inflation. The British economy is struggling, and policymakers will have to assess how much tightening it can withstand to bring inflation down.

TRADE GBP PAIRS

JPY

The Yen extended gains on Tuesday, and USD/JPY dropped below the key 140 level. USD/JPY has been moving close to a six-month peak this week. If the USD/JPY pair declines, it may find support near 137.4. If the pair climbs, it may find resistance at 142.5. 

On Tuesday, a senior official at the Ministry of Finance reported that financial authorities met in response to the weakening of the Yen. Japanese authorities are closely watching the currency market and stated that ‘currency rates should move stably reflecting fundamentals’, and that ‘excessive volatility is undesirable’. The Yen gained strength in response to this announcement, as short traders worry about a potential intervention from the Japanese government to support the Yen.

Labor data released on Tuesday for Japan were optimistic, providing support for the Yen. Unemployment rates dropped to 2.6% in May from 2.8in April, against expectations of a 2.7% print.

The BOJ decided to continue its dovish monetary policy at the bank’s latest meeting in April. This was the first meeting with the newly-appointed BOJ Governor Kazuo Ueda at the helm. Japanese policymakers maintained ultra-low interest rates at the BOJ policy meeting, keeping the central bank’s refinancing rate at -0.10%. 

On Tuesday, Ueda re-affirmed his commitment to the bank’s ultra-loose monetary policy. Ueda said that monetary policy would remain accommodative until the bank’s 2% inflation target became sustainable. He also predicted that price pressures would fall sharply in the next year.

BOJ Core CPI rose to 3.0% year-on-year in April from 2.9% in March. April’s print exceeded expectations of a 2.8% growth, indicating that price pressures in Japan continue to rise. Tokyo Core CPI for April was also hotter than expected, at 3.5% annually, against expectations of a 3.2% print. Inflation in Japan remains steadily above the BOJ’s 2% target, putting pressure on businesses and households. Increased price pressures and wages, raise concerns of a wage-price spiral and may force the BOJ to pivot towards a more hawkish policy. 

Preliminary GDP data for the first quarter of the year were optimistic, showing that the Japanese economy expanded by 0.4% in Q1 of 2023, after reaching stagnation during the last quarter of 2022. The GDP data exceeded expectations of a 0.2% growth in the first quarter of the year, alleviating recession concerns for Japan. The final GDP Price Index printed showed a 2.0% annual expansion, versus 1.2% the previous quarter. Japan’s economic recovery increases the odds of a hawkish pivot in BOJ’s monetary policy.

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Written by:
Myrsini Giannouli

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