Dollar drops after Fed Chair Powell’s testimony

Important calendar events

• JPY: PPI
• EUR: Italian Industrial Production, Eurogroup Meetings
• USD: Final Wholesale Inventories

USD

The dollar retreated on Tuesday and the dollar index fell below 105.0. US treasury yields remained steady, with the US 10-year bond yielding approximately 4.28%. 

One of the key factors that are driving the dollar right now is the US rate outlook. The US Federal Reserve kept interest rates unchanged at its policy meeting in June, within a target range of 5.25% to 5.50%, as expected. The US Federal Reserve has held interest rates steady since last July. 

Fed chair Jerome Powell’s dovish comments put pressure on the dollar last week. Powell stated that significant progress has been made on disinflation, hinting at a rate cut in September. Odds of a Fed rate cut in September are approximately 75% but fluctuate widely. The uncertainty around Fed rate expectations will likely continue in the coming months causing volatility in Forex markets.  

Powell testified on Tuesday's Semi-Annual Monetary Policy Report before the US Senate Banking Committee. In his testimony on Tuesday, Powell stated that the Fed remains focused on ensuring price stability in the US. The dollar was little moved after Powell’s speech, as markets await the second part of his testimony on Wednesday.  

US CPI data for May showed that disinflation in the US is finally progressing. Monthly inflation remained the same in May, after rising by 0.3% in April and against expectations of a 0.1% rise. Headline inflation eased to 3.3% year-on-year in May from 3.4% in April, dropping below expectations of a 3.4% print. Core inflation, which excludes food and energy, rose by just 0.2% in May versus 0.3% anticipated. Annual Core CPI came in at 3.4% versus 3.6% expected, its lowest reading in three years.

Final GDP data showed that the US economy expanded by just 1.4% in the first quarter of the year, which was in line with expectations. Economic growth in the US is slowing down, falling considerably below the 3.4% expansion registered in Q4 of 2023. The US economy is expanding at an increasingly slower pace putting pressure on the dollar, as GDP data have shown expansion by 4.9% in the third quarter of 2023. 

This week markets will focus on the US inflation report on Thursday. Headline inflation cooled to 3.3% year-on-year in May and is expected to drop to 3.1% in June. Signs that inflationary pressures are easing might induce the Fed to start cutting interest rates in September.

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EUR 

EUR/USD edged lower on Tuesday, dropping below the 1.081 level. If the EUR/USD pair declines, it may find support at 1.070, while resistance may be encountered near 1.084.

The Euro has been under pressure since political turmoil in France led to national elections. The first round of French national elections took place on June 30th and the second round on July 7th.

Marine Le Pen’s far-right Party won the first round of France's parliamentary elections, securing 34% of the votes. Le Pen’s National Rally party, however, suffered a surprising defeat in the second round on Sunday, putting pressure on the Euro. The Left-wing coalition gained the most seats in the National Assembly. The Left-wing party, however, did not win an outright majority required to form a government. Last week’s election result has led to a hung parliament and concerns of political instability in France are putting pressure on the Euro. The euro continued to decline on Tuesday as markets had time to digest the economic implications of a hung parliament in France.

The ECB lowered its Main Refinancing Rate by 25 basis points to 4.25% in June. Eurozone inflation remains sticky and may slow down the pace of future rate cuts. ECB President Christine Lagarde has stated that the central bank’s policy will remain data-driven. 

Eurozone inflation eased to 2.5% in June from 2.6% in May putting pressure on the Euro. Core CPI, which excludes food and energy, however, rose by 2.9% on an annual basis in June against expectations of a 2.8% print. 

The Eurozone economy expanded by 0.3% in the first quarter of the year, which was in line with preliminary estimates. GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero. 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. 

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GBP 

GBP/USD dipped to the 1.278 level on Tuesday. If the GBP/USD rate goes up, it may encounter resistance near 1.284, while support may be found near 1.260. 

The Sterling gained strength after the Labour Party achieved a landslide victory at the British national elections last week. Keir Starmer's center-left Labour Party won 410 of the 650 seats in the parliament and will form the next British government. Former Prime Minister Rishi Sunak's Conservatives secured just 119 seats. The Labour Party’s decisive victory is raising hopes of political stability in the UK boosting the sterling.

The BOE kept interest rates steady at its latest monetary policy meeting in June. The BOE maintained its official rate at a 16-year high of 5.25. The BOE's Monetary Policy Committee voted 7-2 to keep rates on hold with two members voting to cut interest rates by 25 basis points.

Markets are pricing in a rate cut in September with approximately 70% probability, while a rate cut by November is fully priced in. Rate cut expectations have shifted from two rate cuts and a total of 50 basis points of rate cuts in 2024 to approximately 35 bp reduction in rates within the year. 

Price pressures in the UK are easing, raising the odds of a BOE rate cut by September. British headline inflation eased to 2.0% on an annual basis in May from 2.3% in April, which was in line with expectations. Annual Core CPI, which excludes food and energy, fell to 3.5% in May from 3.9% in April. British inflation dropped to the BOE’s target for the first time in nearly three years indicating that the BOE’s hawkish monetary policy has been paying off. 

The British economy is showing signs of improvement reducing the odds of a dovish pivot by the BOE. GDP data showed that the British economy expanded by 0.7% in the first quarter of the year against initial estimates of 0.6% growth. The UK slipped into recession last year as the economy contracted by 0.3% in the final quarter of 2023. 

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JPY

USD/JPY gained strength on Tuesday, rising to the 161.4 level. If the USD/JPY pair declines, it may find support near 160.2. If the pair climbs, it may find resistance near the psychological level of 162.0.

The Yen has been under pressure since the BOJ disappointed expectations of a hawkish shift at its latest meeting. The BOJ pivoted to a more hawkish policy at its meeting in March, ending its negative interest rate policy and raising the benchmark interest rate into the 0% - 0.1% range. 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. 

BOJ Governor Kazuo Ueda has hinted that the central bank would ease its bond purchasing at the next meeting in July. BOJ officials, however, had not given any specifics for paring back their bond-buying program till now. The BOJ released on Tuesday a summary of opinions collected in a survey of bond market participants. The BOJ’s summary of opinions reflects the market’s inclination to curtail the central bank's bond-purchasing program. A growing demand among bond market participants for tapering of BOJ bond purchases might induce the central bank to pivot to a more hawkish policy. 

BOJ officials have been attempting to boost the Yen, warning traders against speculative short selling of the currency. Threats of an intervention, however, have been issued for many months now and no longer have a significant impact on markets. The BOJ intervened to support the Yen in 2022 and again this year in late April and early May, when USD/JPY surged above the 160.0 level. 

On the data front, inflation in Japan remains weak but rising. Headline inflation rose to 2.5% year-on-year in May from 2.2% in April. BOJ Core CPI rose to 2.1% on an annual basis in May from 1.8% in April, exceeding expectations of 1.9%. Rising inflation in Japan increases the odds of another BOJ rate hike later in the year. Tokyo Core CPI rose to 2.1% year-on-year in June from 1.9% in May against estimates of a 2.0% reading. 

Preliminary GDP data for Q1 of 2024 for Japan showed that the country has slipped into recession. Japan’s economy shrank by 0.5% in the first quarter of the year against expectations of a 0.3% drop. Japan’s economy registered a small expansion by 0.1% in the final 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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