Dollar under pressure by dovish Fed comments

Important calendar events

• JPY: Tertiary Industry Activity
• EUR: Italian Trade Balance, EU Trade Balance, German ZEW Economic Sentiment, EU ZEW Economic Sentiment, ECOFIN Meetings
• USD: Core Retail Sales, Retail Sales, Import Prices, Business Inventories, NAHB Housing Market Index

USD

The dollar dipped after Fed Chair Powell’s comments on Monday and the dollar index dropped below 104.2. The dollar pared losses later in the day, however, as markets had time to analyze Powell’s speech and the dollar index rose back to 104.3. US treasury yields dipped on increased rate cut expectations, with the US 10-year bond yielding approximately 4.22%. 

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. 

The dollar was under pressure on Monday by Fed Chair Jerome Powell’s dovish comments. At the Economic Club of Washington DC, Powell reiterated that the central bank is looking for “greater confidence” that disinflation is progressing. Powell stated that the Fed will not wait until inflation hits 2% to cut interest rates. 

US inflation surprised on the downside last week, registering its lowest reading in three years. Headline inflation cooled to 3.0% year-on-year in June from 3.3% in May against expectations of a 3.1% reading. Monthly inflation shrank by 0.1% in June against the 0.1% growth expected. Core inflation, which excludes food and energy, rose by just 0.1% in June from 0.2% in May dropping below expectations of 0.1% growth. Signs that inflationary pressures are easing might induce the Fed to start cutting interest rates in September.

Rate cut expectations in September were catapulted above 90% after the release of the US inflation report last week, putting pressure on the dollar. The uncertainty around Fed rate expectations will likely continue in the coming months causing volatility in Forex markets.

On the data front, 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. 

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EUR 

EUR/USD edged higher on Monday, rising above 1.091. If the EUR/USD pair declines, it may find support at 1.079, while resistance may be encountered near 1.092.

This week the European Central Bank is meeting on July 18th under a climate of political instability in France, one of the Eurozone’s leading economies. The ECB is expected to keep interest rates steady this week, but also to prepare the ground for a rate cut in September. Traders this week will focus on the ECB’s forward guidance, which is expected to point to another rate cut in September.

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 traded sideways on Monday, moving near a four-month high of 1.297. If the GBP/USD rate goes up, it may encounter resistance near 1.313, while support may be found near 1.275. 

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. 

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 0.4% in May following stagnation the month before and against expectations of 0.2% growth. Moreover, 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. 

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. 

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JPY

USD/JPY moved precariously close to the key 162.0 level last week but plummeted to the 158.0 level at the end of the week, raising intervention speculation. On Monday, USD/JPY remained steady, fluctuating around the 157.9 level with low volatility. If the USD/JPY pair declines, it may find support near 155.1. If the pair climbs, it may find resistance near the psychological level of 162.0.

The Yen spiked after the release of the US inflation report last week and USD/JPY dropped sharply by over 400 pips in half an hour. Even though the dollar weakened against all rivaling currencies, the drop in the USD/JPY was steep enough to raise intervention speculation. The currency rate had been trading close to a 38-year high earlier in the week, fueling reports that the Japanese government has once again intervened to support the currency. So far Japanese officials have not commented on those rumors, but many analysts believe that the sudden reprieve in the Yen’s downfall was engineered by the BOJ. 

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. 

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.  

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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