US Dollar Fundamental Outlook: Oh S**t, Inflation is at 7.5%, the Highest in 40 Years!
The highlight last week was the US CPI inflation report that surpassed consensus forecasts. The headline y/y CPI was 7.5%, while the core measure stood at an also high 6.0%! If it weren’t for Jerome Powell and Janet Yellen telling us it is all transitory, we would all be freaking out now.
Jokes aside, the markets also (for now) tend to believe inflation is transitory and that it will soon start to come down. Yet, that isn’t stopping them from pricing in an even more hawkish Fed in the coming months. Following that CPI inflation report last Thursday, Fed rate hike odds in futures markets surged, now almost fully pricing (over 90%) a 50bp hike in March from around 30% before the CPI report. St. Louis Fed President James Bullard (voting FOMC member) was also speaking in favor of more drastic measures such as a larger 50bp rate hike and even an inter-meeting emergency hike, all helping to reinforce the hawkish Fed story.
It’s worth a reminder here that the Fed usually delivers what the markets expect it to do with a probability of above 60-70 percent. There is still time until the next meeting (March 16) – but unless those probabilities come down – the Fed will most likely deliver that 50bp hike. All of this “Fed hawkishness” is supportive for the US dollar, and as long as the Fed leads the hawkish “pack” among central banks, it will be hard for the other currencies to stand up against “king dollar.”
On the US calendar, Wednesday will be the busiest day, seeing the release of the retail sales report and then the FOMC minutes later in the day. Consumer spending is an important metric that the Fed closely monitors, and a solid retail sales report should confirm the strength of the US economy. The FOMC minutes may provide more details about the Fed’s tightening plans, which likely means we can expect a bullish USD reaction, if any. Several FOMC members have speeches throughout the week, including Bullard again today and on Thursday. More Fed officials favoring a 50bp March hike or faster QT (quantitative tightening) would likely refuel the USD’s bullish move.
Euro Fundamental Outlook: ECB Starts Pushback Against Markets’ (Too) Hawkish Speculations
In our previous weekly Fx edition (Feb 7), we said, “it’s questionable how sustainable the EUR rally based on a hawkish ECB can be in the months ahead.” It seems we didn’t have to wait too long for ECB officials to start pushing back against the markets’ too aggressive pricing and expectations for ECB rate hikes. As a result, the EUR retraced some of its gains over the past week, and it seems more could follow this week (already happening today).
Nonetheless, nobody can deny the shift at the ECB from ultra-dovish to less dovish (or neutral). This is a big deal for the euro and will likely prevent material losses for the currency over the coming months (which would’ve been much more likely if the ECB stayed firmly in the uber-dovish camp). However, the ECB will still lag most of the other central banks, so this “relative” dovishness should keep the euro pressured for the time being.
ECB President Christine Lagarde and chief economist Philip Lane spoke last week. Both stressed that the Eurozone’s inflation situation is different from other countries and is not accompanied by wage growth. Indeed, Eurozone CPI levels are still lower than elsewhere and (importantly) are mainly driven by the rise in energy prices (oil and especially gas). This situation suggests that if energy prices start to fall, the ECB will likely be the first to abandon any hawkish plans as Eurozone inflation would start falling fast.
Given this dynamic of an “ECB talking about rate hikes but not actually serious about doing it”, it seems probable that the euro (and mainly the EURUSD pair) can draw out some broader range in the weeks ahead, especially going into that March 10 ECB meeting (where they should provide more details about their recent policy stance changes).
The EUR calendar is light for this week. Of the most notable events, Lagarde and Lane will speak again, and the markets will surely listen closely. The German ZEW Economic Sentiment is due tomorrow (Tue).
EURUSD Technical Analysis:
EURUSD stopped at the 200-week moving average just under the 1.15 level (actual 1.1491) and is now back below 1.14, even trading to 1.13 earlier today. This goes to show that while the bearish trend (channel formation) may have been broken, an uptrend doesn’t necessarily follow. At least not immediately it seems, and the rejection below 1.15 suggests (like the fundamentals) that range-trading is a probable scenario for EURUSD at this stage.
The key resistance to the upside remains at the 1.15 zone. Above it, perhaps even stronger resistance awaits in the 1.17 zone.
To the downside, 1.13 is an important support zone. Below it, there is support at 1.1250 and the low at 1.1150. Further down,1.10 comes into focus as the next major support area.
British Pound Fundamental Outlook: GBP Traders Zoning In on CPI Inflation Report
Following the volatile gyrations on the BOE surprise, the pound has had a mixed performance over the past two weeks. GBPUSD is stuck in a mere 150 pips range, while EURGBP is back to where it was before those February 3 BOE and ECB meetings. These developments confirm our expectations for a generally directionless GBP and mostly range-bound trading ahead on Fx pairs like GBPUSD and EURGBP.
The Bank of England is hawkish, but so is the Fed and other central banks. In this sense, there is not much “relative” Fx advantage for the pound against these currencies. Thus, low-yielding currencies like JPY and CHF remain the main candidates against which GBP can have some edge. But this narrative strongly rests on the premise that there will be no major risk aversion episodes. If risk sentiment worsens, then GBP would likely suffer versus JPY and CHF.
On the domestic front, the UK economy is performing OK, giving the BOE leeway to hike interest rates and tighten policy in order to combat inflation. The UK calendar this week features key economic reports that will affect BOE policy. The three jobs reports are out on Tuesday (Average Earnings, unemployment, claimant count), followed by CPI inflation (Wed), and retail sales (Fri). Solid figures in these reports can provide some modest temporary support for the pound, but a sustainable rally seems unlikely at this point.
GBPUSD Technical Analysis:
GBPUSD bounced off the 1.3150 – 1.33 support zone in December, then rallied to a high of 1.3748 in mid-January and following the rejection at the 55-week moving average there (blue), has now stabilized around the 1.35 zone. Based on the weekly chart shown below, it seems the December lows and January highs are the key support and resistance zones at this juncture.
In addition to the 55-week MA, the 1.37 – 1.38 resistance zone is helped by past lows there. Conversely, the 1.3150 – 1.33 support zone has a combination of the 100-week (orange) and 200-week (red) MAs with past major highs. It seems thus that GBPUSD will need strong momentum to break through either of these zones.
In the event of a breakout, more distance resistance to the upside is located at 1.40 and then at major cycle highs around 1.43. To the downside, if 1.3150 – 1.33 breaks, there is no support until the 1.25 area.
Japanese Yen Fundamental Outlook: Uber-Dovish BOJ Reasserts QE & YCC Policy
BOJ Governor Kuroda quelled any JPY bulls looking for a similar hawkish shift at the BOJ to what we recently saw from the ECB. The BOJ last Thursday announced that they will buy unlimited quantities of Japanese Government bonds to keep the yield curve control policy (YCC) intact. This followed as the 10-year Japanese yield recently approached the 0.25% upper threshold the BOJ has set for itself.
With Government bond yields climbing steadily elsewhere in the world due to rising inflation, Japan is a different story. Inflation is low, and the uber-dovish BOJ has just confirmed that they will keep yields close to 0%. This cements the JPY currency as one of the least attractive to hold in Fx and should continue to exert downward pressure (JPY pairs bullish).
However, any discussion of the yen cannot go without a word on risk sentiment. Indeed, while the BOJ’s policies will keep the bearish pressures on the yen intact, equity market volatility and risk aversion are doing the opposite. The JPY was quick to react and strengthen on the late Friday sell-off in stocks, induced by fears for a Russia-Ukraine war. This again confirms that both risk sentiment and movements in bond yields (especially US Treasuries) remain key drivers for JPY and can still pull it in opposing directions in the current environment.
USDJPY Technical Analysis:
USDJPY managed to climb and hold above 115.00 last week, but the attempt at the 116.50 resistance zone was rejected again. USDJPY is yet to break any meaningful levels and largely is still well within its already established ranges and channels.
The 2 channel formations we’ve discussed in recent weeks remain in key focus (see chart). The key support for both seems to be lining up at the 114.00 area. A break to the downside here will likely clear the road for steeper losses, with 112.00 being the next important support zone.
To the upside, above the 116.50 zone, the next resistance is at 118.00.