The common currency extended recent losses by falling below the $1,06 key support level this morning, for the first time since the early days of the year, giving up some significant gains of the latest rally, as the prospect of higher interest rate hikes from the Federal Reserve is favoring the dollar against the euro.
EUR/USD pair hit a six-week low of $1,0580 this morning after data released Friday showed that Germany, the Eurozone’s largest economy contracted at the end of the year, shrinking by 0.4% vs expected -0.2% in the fourth quarter of 2022 compared with the previous three months.
A lower-than-expected German Q4 GDP is a negative/bearish catalyst for the common currency, especially on a day like this today, which completed a year since Russia’s invasion of Ukraine, which tanked the EU economy.
Euro’s retracement from early February’s highs of $1,10 to the current lows is part of a broader rebalancing in the forex market in favor of the U.S. dollar against major G10 growth-sensitive currencies such as the Euro, Pound Sterling, and the Australian dollar as the market sentiment remains fragile amid fears of a more hawkish Federal Reserve to curb inflation.
Investors have increased their worries about more interest rate hikes by the Federal Reserve in recent weeks, following some stronger-than-expected U.S. macroeconomics, labor, and inflation readings, which are signs of resilience in the world’s largest economy.
The fundamentals are now favoring the dollar against the euro as investors braced for U.S. interest rates to be higher for longer, with the DXY-U.S. dollar index, which tracks the value of the greenback against six major peers, climbing over 104,70 this morning ahead of a reading on the PCE-Personal Consumption Expenditures index – the Fed’s preferred inflation gauge.
The PCE price index is a wide indicator of the average increase in prices for all domestic personal consumption and is widely expected to reiterate that U.S. inflation remained elevated in January.
The U.S. dollar has posted a significant rebound across the board since February 01, 2023, gaining support from the stronger-than-expected U.S. macroeconomic data, the hawkish messages by the policymakers ahead of the key U.S. CPI- consumer inflation data due on Tuesday that might give more clarity over the Fed’s rate hike intentions.
More robust jobs data and solid economic readings saw markets last week have to recalibrate expectations for how high the Federal Reserve may need to raise rates this year to curb the record-high inflation.
On top of that, Federal Reserve speakers reiterated their hawkish messages that there is more work to be done to tame inflation, triggering a rebound on the dollar against other currencies.
Following a four-month downturn momentum, the DXY-U.S. dollar index which tracks the greenback against six major peers retreated from the multi-year high of 115 hit in late September 2022 to yearly lows of nearly 100 level at the end of January 2023.
DXY-U.S. dollar index, 2-hour chart
However, after the FOMC policy meeting on February 01, 2023, the dollar enjoys a strong rebound toward the 104 level, driven by the hot U.S nonfarm payrolls reading for January, the sharp bounce in the services ISM last month.
Surging yields give support on the dollar as well, with the yield on the 10-year bond bouncing from the lower end of its range that goes back to the middle of last September (3.30%) to the upper end near a five-week high of 3.75% on expectations for more rate hikes by the Fed.
CPI-inflation data due on Tuesday:
Investors look ahead to the well-expected January U.S. CPI consumer inflation data due on Tuesday that might provide more cues on monetary policy and the price trajectory of the dollar.
While the reading is expected to show further easing in inflation in January 2023 to 6.2% vs 6.5% in December 2022, it is still expected to remain relatively high, which could invite more interest rate hikes by the Federal Reserve.
A risk-off mood dominates financial markets on the first trading day of the week, with the U.S. dollar rebounding across the board, while the risk-sensitive currencies are retreating from the recent multi-month highs after a hot US jobs report on Friday last week could provide more room for the Federal Reserve to continue tightening interest rates to combat inflation.
The investment sentiment has soured since last Friday, with investors having a more defencing approach and taking some profits out of the latest four-month rally.
The DXY-U.S. dollar which tracks the value of the greenback against six major peers has rebounded above the 103 mark this morning for the first time since mid-January 2023, getting support from a strong U.S. non-farm payroll report, and higher bond yields.
DXY-U.S. dollar index, 2-hour chart
On Friday, the U.S. Labour Department announced that NFP-nonfarm payrolls surged by 517,000 jobs in January vs the 185,000 market expectation. Combined with the rebound in the service industry in the same month, it triggered anxiety among investors regarding the outlook on the Fed’s monetary policy.
The unexpected spike in the labour data has shown that U.S. employment remains strong and resilient despite the slowdown in economic activity, the record-high inflation, and the growing fear of a recession.
The better-than-expected macroeconomics and employment data give the Federal Reserve more headroom to stay hawkish for longer and hike the rate by another two times this year, which could weigh heavily on the dollar price trajectory and sentiment on other risky assets.
The recovering dollar is causing significant losses across the board, with the Euro falling back from recent highs of $1.10 toward $1.0750, the Pound Sterling retreating from $1.24 to $1.20, the Japanese Yen falling from ¥128 to above ¥132, while the risk-sensitive Australian dollar is trading below $0.69 level after touching a six-month high of $0.7150 last week.
The Bank of England raised- as widely expected- its key interest rate by another 50 basis points to 4% on Thursday, the highest it’s been since the 2008 financial crisis, to fight the inflation which is still running above the 10% level (10.5% CPI in December).
Despite the new rate hike, the Pound Sterling fell to as low as the $1.2180 level on Friday morning, nearly 2% down from a weekly high of $1.24, before stabilizing to nearly $1.2260.
Meanwhile, the yield on the 10-year Gilt (UK government bond) dropped to nearly 3%, its lowest since November 2022 (it topped at nearly 4.60% in mid-October), following some more-dovish messages-than-the market had expected from BoE.
During the regular press conference after the rating announcement, Governor Andrew Bailey had hinted that the Bank of England may have finished raising interest rates after the 50 basis points hike on Thursday, which had increased the possibility of an end to its policy tightening.
According to the BoE’s calculations, the current market expectations of a peak in rates around 4.5% in mid-2023 would push inflation below its 2% target in the medium term. That suggests it doesn’t see the need to raise the Bank rate much more, if at all, although it was careful to add those uncertainties around this outlook are high and that “the risks to inflation are skewed significantly to the upside”, said the Governor.
Risk for a recession in the UK in 2023:
The surging rates could add further pressure on the already-beaten-down U.K economy, which is struggling with record-high energy and food prices, with the inflation rate -10.5%- running much higher than in the U.S. and Eurozone, amid a tighter-than-expected labor market coupled with wages pressure.
That’s why the IMF- International Monetary Fund expects the U.K. to be the only G7 economy to fall into recession in 2023, with the annual GDP to contract some 0.6%, predominantly due to higher taxes, rising interest rates and the high cost of energy as well as lower government spending.
The first trading month of the year -January- came with a sharp rally in digital coins across the board despite general worries that a hawkish Federal Reserve will plunge the U.S. economy into recession, coupled with the surging dollar and the negative sentiment after last year’s bankrupts in the crypto ecosystem.
Bitcoin, the largest coin by market cap, has rallied over 40% so far in 2023, bouncing from the lows of the $16,000 mark toward the five-month highs of $23,000-$24,000 at the end of January.
The leading cryptocurrency hasn’t given investors such an uplifting January since 2013, while it also posted its best month since a 40% rally in October 2021, when prices jumped above the $60,000 level.
Hence, the return on crypto buying has pushed the total market capitalization for cryptocurrencies to move above the $1 trillion key psychology level, according to Coinmarketcap, while the global crypto volume has risen to $5.5 trillion, which is up 61% since the beginning of the year, according to crypto indexing platform Nomics.
Bitcoin had a rough time all throughout 2022, falling from the record highs of $64,000 to multi-year lows of $15,000, helped by a large number of long liquidations and short selling that were fuelled by a variety of bankruptcies in the crypto ecosystem.
Bitcoin soars over 40% in January on Fed expectations:
The rally in risk-sensitive cryptocurrencies was driven by expectations of a Federal Reserve pivot to slower interest-rate hikes as inflation continued to cool.
The Fed is widely expected to announce a 25-basis point rate increase later today at the end of its monetary policy meeting, increasing the Fed funds rate to a 4.5%-4.75% range.
Market participants expect another 25-basis point rate in March, to 4.75%-5%, but then investors are leaning toward no more hikes.
Investors will be also focused on Fed Chair Jerome Powell’s comments for any signal about a pause in the tightening cycle, future rate hike outlook, inflation, and economy, which could weigh on the dollar and the market risk sentiment.