Markets poised to follow Fed’s signals

Important calendar events

• JPY: BOJ Summary of Opinions, Preliminary Industrial Production, Retail Sales, Consumer Confidence, Housing Starts
• EUR: German Retail Sales, German and French Preliminary CPI, German Retail Sales
• GBP: Nationwide HPI
• USD: ADP Non-Farm Employment Change, Employment Cost Index, Chicago PMI, Federal Funds Rate, FOMC Statement, FOMC Press Conference

USD

The dollar remained steady on Tuesday, with the dollar index approximately at the 103.5 level. US treasury yields also remained firm, with the US 10-year bond yielding approximately 4.08%. 

Robust US economic activity data boosted the dollar on Tuesday. CB Consumer Confidence in January rose above expectations, indicating that financial confidence is rising in the US. JOLTS Job Openings also exceeded expectations. Tuesday’s data showed that 9.03M new jobs opened in December in the US labor market up from 8.93M in November and against 8.73M anticipated.

This week all eyes will be on the US Federal Reserve and the monetary policy decision on the 31st. The Fed kept interest rates unchanged at its December meeting, within a target range of 5.25% to 5.50%. The US central bank is expected to leave interest rates unchanged again this week. 

Fed Chair Jerome Powell’s press conference after the meeting will attract much attention as traders will focus on the central bank’s forward guidance. Market expectations of future rate cuts fluctuate wildly and are one of the primary drivers of the dollar.

Markets are pricing in a dovish shift in the Fed’s policy as soon as March with over 60% probability. Most analysts, however, predict that the central bank will hold off interest rate cuts until May.

If the Fed removes the tightening bias from its policy statement, markets will interpret this as a sign that the central bank is ready to pivot, which will weaken the dollar. If, on the other hand, the central bank retains a hawkish stance, we expect to see the US dollar and treasury yields go up.

Core PCE price index rose by 0.2% in December according to data released on Friday, which was in line with expectations. Core PCE price index dropped to 2.9% year-on-year in December from a 3.2% print in November. This is the Federal Reserve’s preferred inflation gauge, and a lower print indicates that price pressures in the US are easing.

Advance GDP for the final quarter of 2023 showed that the US economy expanded by 3.3% against the expectation of a more modest 2.0% growth. The US economy is expanding at a slower pace, as final GDP data have shown expansion by 4.9% in the third quarter of 2023, but economic growth in Q4 of 2023 exceeded expectations. Advance GDP Price Index for the final quarter of 2023 came in at 1.5% against expectations of 2.3% and a final print of 3.3% in the previous quarter. This is an indicator of inflation, and a lower print indicates cooling price pressures in the US.

Headline inflation rose by 3.4% year-on-year in December from a 3.1% print in November against the expectation of a 3.2% raise. Monthly CPI rose by 0.3% in December, exceeding expectations of a 0.2% print. Core CPI, which excludes food and energy, rose by 0.3%, in line with expectations. Inflation in the US remains sticky and may put pressure on the Fed to keep interest rates at high levels for longer. 

TRADE USD PAIRS

EUR 

EUR/USD traded sideways on Tuesday, oscillating around the 1.084 level. If the EUR/USD pair declines, it may find support at 1.072, while resistance may be encountered near 1.095.

The Eurozone economy does not show sufficient signs of recovery and is on the brink of recession. Preliminary GDP data released on Tuesday for the final quarter of 2023 showed that the Euro Area economy remained stagnant, narrowly avoiding recession. The German economy shrank in the final three months of 2023. Preliminary GDP data showed that the EU’s leading economy shrank by 0.3% in Q4 of 2023.

Revised GDP for the Euro area showed that the Eurozone economy contracted by 0.1% in the third quarter of the year, which was in line with expectations. The Eurozone economy barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1 of 2023. The Eurozone economy is struggling and cannot withstand much further tightening. 

The ECB kept interest rates unchanged at 4.50% as expected at its January meeting. The ECB press conference following the conclusion of the meeting did not hold many clues on the central bank’s policy direction. ECB President Christine Lagarde stated that interest rates are currently at sufficiently high levels to bring inflation down to the central bank’s 2% target over time. Lagarde also reiterated that ECB interest rates will remain at sufficiently restrictive levels for as long as necessary. 

Markets are pricing in rate cuts this year, although ECB policymakers are concerned about persistent inflationary pressures in the Eurozone. The ECB is expected to pivot to a more dovish policy later this year, but the timeline is still uncertain. Markets anticipate rate cuts of around 140 bps in 2024. Odds of ECB rate cuts starting in April are rising, and markets are pricing 50bp of rate cuts by June.

Final EU CPI data for December showed that Eurozone inflation remains sticky, indicating that the ECB still has some ground to cover to ensure that inflation drops sustainably. EU Final CPI for December came at 2.9% year-on-year from 2.4% in November. Core Flash CPI for December dropped to 3.4% from a 3.6% print in November, which was in line with expectations.

TRADE EUR PAIRS

GBP 

GBP/USD traded sideways on Tuesday around the 1.270 level. If the GBP/USD rate goes up, it may encounter resistance near 1.270, while support may be found near 1.260.

The Sterling is under pressure this week on expectations that the BOE may signal a dovish shift in its monetary policy later this week. The BOE maintained its official rate at 5.25% at its latest policy meeting. BOE Governor Andrew Bailey has kept a hawkish stance, stressing that inflationary pressures in the UK remain high and that further tightening might be required to bring inflation down to the bank’s 2% target. 

The BOE will announce its next interest rate decision on Thursday, a day after the highly-anticipated Fed meeting. The Fed’s policy decision on the 31st is expected to affect the GBP/USD rate considerably. If the Fed shows signs of a dovish pivot earlier than the BOE, the Sterling might gain strength against the dollar.   

The BOE will likely keep interest rates on hold for some time to bring inflation down. Market expectations of the BOE’s future direction reflect the need to keep interest rates in restrictive territory for some time, with BOE rate cuts not expected before May. Traders are poised for any change in the BOE’s forward guidance on Thursday that may signal a pivot in the central bank’s policy. 

Headline inflation rose to 4.0% year-on-year in December from 3.9% in November, against expectations of a 3.8% print. This marked the first rise in consumer inflation in 10 months, increasing the odds the BOE will keep interest rates at high levels for longer. Annual Core CPI, which excludes food and energy, grew at the same pace of 5.1% in December as in November, beating the 4.9% forecast. 

The British economy remains fragile, reinforcing the notion that the BOE has reached its peak interest rates. Monthly GDP rose more than expected in November, however, inspiring more optimism on the UK’s economic outlook. The British economy expanded by 0.3% in November against expectations of a 0.2% growth and 0.3% contraction in October. Final quarterly GDP data revealed that the British economy contracted by 0.1% in the third quarter of 2023, against expectations of stagnation. The British economy expanded by 0.3% in the first quarter of the year and 0.2% in the second quarter. 

TRADE GBP PAIRS

JPY

USD/JPY edged higher on Tuesday, rising to the 147.8 level. If the USD/JPY pair declines, it may find support near 146.6. If the pair climbs, it may find resistance near 148.8.

Labor data released on Tuesday for Japan revealed that Japan's Unemployment rate fell to 2.4% in December from 2.5% in November, which was in line with expectations.

The BOJ kept all policy levers unchanged at its January meeting, maintaining its ultra-easy monetary policy. The BOJ has been keeping interest rates at a negative level, putting pressure on the Yen. The BOJ has so far maintained its dovish bias as other major central banks, and especially the Fed, have raised interest rates to high levels. 

BOJ Governor Kazuo Ueda has hinted at a policy shift down the road. Ueda stated that the likelihood of Japan sustainably achieving the bank's 2% inflation target was gradually increasing. Ueda’s comments increased market odds of a hawkish pivot later in the year.  

An immediate policy shift is not expected yet, but markets are pricing in the first BOJ rate hike in April with over 50% probability. A rate hike by June is considered almost certain, with market odds giving over 90% probability of a shift in the BOJ’s monetary policy by June. Only a small rate hike of 10bps is considered likely, which would bring the BOJ’s interest level from negative to zero. 

Inflationary pressures are not sufficiently high in Japan to justify a shift to a more hawkish policy yet. PPI remained flat year-on-year in December, exceeding expectations, however, of a 0.3% decline. National Core CPI data showed that Japanese inflation cooled further in December with headline inflation at 2.3% year-on-year from a 2.5% print in November. Tokyo Core CPI also dropped slightly to 2.1% in December from 2.3% in November. 

Final GDP data for the third quarter of the year showed that Japan's economy contracted by 0.5% in the third quarter against earlier estimates of a 0.5% contraction. The Japanese economy expanded by 1.2% in the second quarter of 2023, showing that the country’s economy is shrinking and is on the brink of recession. Final GDP Price Index showed a 5.3% annual expansion in Q2, versus 3.5% the previous quarter. This is a measure of inflation, which shows that inflationary pressures are rising in Japan, increasing the odds of a hawkish shift in the BOJ’s policy. 

TRADE JPY PAIRS

The content provided in this material and/or any other material that this content is referred to, whether it comes from a third party or not, is for information purposes only and shall not be considered as a recommendation and/or investment advice and/or investment research and/or suggestions for performing any actions with financial products or instruments, or to participate in any particular trading strategy and cannot guarantee any profits. Past performance does not constitute a reliable indicator of future results. TopFX does not represent that the material provided here is accurate, current, or complete and therefore shouldn't be relied upon as such. This material does not take into account the reader's financial situation or investment objectives. We advise any readers of this content to seek their own advice. Without the approval of TopFX, no reproduction or redistribution of the information provided herein is permitted.

Written by:
Myrsini Giannouli

Share the article: