Three of the world’s largest central banks, the Federal Reserve, European Central Bank, and Bank of England will hold policy meetings in the week ahead to fight a 40-year record high inflation.
The rate hikes decisions will be in the spotlight this week, with investors expecting both the ECB and BoE to increase their interest rates by 50 basis points. In comparison, the Federal Reserve is widely expected to slow the pace of interest rate hikes to a 25 basis points in the face of cooling inflation in the United States.
Dovish signals from the Federal Reserve?
The U.S.-based Federal Reserve will have its FOMC policy meeting on Wednesday, Feb. 01, where investors expect the world’s largest central bank to decide a 25-basis point rate increase to a range of 4.5% to 4.75%, slowing the size of the increase for a second straight meeting.
The Federal Reserve hiked its Fed’s Fund rates by 75 basis points four straight times last year before approving a 50-basis point move in December.
The eased inflation in recent months had eventually encouraged Federal Reserve into a less tightening monetary policy, at a time the U.S. labor market and economic growth also cooled in late 2022.
Expectations of slower rate hikes have also dented the U.S. dollar and Treasury yields. The DXY- U.S. dollar index which tracks the greenback against six major currencies, posted a seven-month low of 101.50-mark last week, while the yields on the 10-year Treasury fell as low as 3.30% in mid-January, further pressuring the dollar against major peers.
Any dovish signals from Fed’s statement are likely to be harmful to the greenback and positive for risky-sensitive assets such as tech and growth stocks, growth-led currencies, and cryptocurrencies.
ECB and BoE ahead of 50 bps rate hike:
Both the European Central Bank (ECB) and the Bank of England (BoE) will meet on Thursday, February 02, with markets expecting a rate hike of 50 basis points to 3% and 4% respectively.
Investors will also look for any signals of how much further and how fast policymakers intend to go since inflations still stand well above the ECB’s and BoE’s 2% inflation target.
The weaker dollar together with the hawkish rhetoric from ECB and BoE have helped Euro and Pound Sterling to bounce off from their multi-year lows of $0.95 and $1.04 a dollar, hit at the end-September 2021 to the current highs of $1.09 and $1.24.
Euro jumped above the $1.09 key resistance level on Monday morning for the first time since early April 2022, driven by both the hawkish signals from the European Central Bank on interest rates hikes, and the recent weakness of the U.S. dollar on growing expectations for a less aggressive Federal Reserve in the coming months.
Hawkish signals by ECB boost Euro:
Investors increased bets on the common currency this morning, cheering the hawkish comments by European Central Bank (ECB) governing council member Klaas Knot, who said European interest rates would rise by 50 basis points in February and March and continue climbing in the months after.
According to Reuters, Knot is considered a hawk among policymakers, and the comment was taken as pushback against recent reports that the ECB would scale back to 25 basis points moves from March.
Adding to those hawkish comments by Knot, ECB President Christine Lagarde pushed back against economist’s opinion that it would slow the pace of rate hikes given recent retreats in EU inflation. At the same time, the ECB will hold its next rate-hike policy meeting on February 02.
Hence, sentiment in broader European financial markets has started to improve following the falling energy and inflation numbers. The retreating crude oil and natural gas prices have been major catalysts for Euro to bounce off from its yearly lows of $0.95 hit at the end of September to the current highs of $1.09.
European natural gas Dutch TTF prices, currently trading at nearly €65/MWh, have fallen 62% since early December, and more than 80% since topping at €340/MWh in late August, removing significant inflation pressure from the Eurozone’s economy, and sharply increasing the optimism that EE could avoid a hard landing-recession, which eventually weighed positively on EUR/USD pair.
A softer U.S. dollar lifts the Euro:
Forex investors are now betting that falling inflation in the United States will eventually encourage Federal Reserve into less tightening monetary policy, pulling down the U.S. dollar against Euro and other major peers.
The DXY- U.S. dollar index which tracks the greenback against six major currencies, including the Euro which has a 60% weight on the index, hit a fresh seven-month low of 101.50 mark, tumbling nearly 12% since peaking at 115 in early October, on growing bets that the Federal Reserve will slow its pace of rate hikes to prevent a further slowdown in the world’s largest economy.
Yet, markets remain uncertain over where U.S. interest rates will peak, given that inflation is still trending near 40-year highs, and remain well above the Fed’s 2% annual target. Traders see rates peaking at 4.89% by June 2023, with a 25-basis point rate hike baked in for February 01 (FOMC meeting).
The Federal Reserve hiked the interest rate by 0.75 percentage points four straight times last year before approving a 0.5 percentage point move in December.
Expectations of slower rate hikes have also dented the U.S. Treasury yields, with the 2-year and 10-year yields falling to four-month lows of 4.14% and 3.48% respectively, further benefiting the euro against the dollar.
Cryptocurrencies rallied sharply across the board in recent weeks on improved risk sentiment and a weaker dollar following the growing bets that Federal Reserve will raise interest rates at a slower pace in the coming months, taking some pressure off risky assets such as digital assets.
The crypto rally was boosted during the weekend following Friday’s data that showed U.S. Consumer Price Index (inflation rate y-y) eased further in December 2022 to 6.5% vs 7.1% in November, which weighed negative on the greenback and U.S. Treasury yields.
Due to a falling dollar and bond yields coupled with a high appetite for risk assets (supports bullish moment on cryptos), the price of the crypto market leader, Bitcoin (BTC), has added $5,000 per coin, or over 30%, since the start of 2023, breaking above the $21,000 level for the first time since FTX’s bankruptcy at early November 2022.
BTC/USD pair, 2-hour chart
Ethereum, the second largest token after Bitcoin, has gained nearly 35% year-to-date, hovering at nearly $1,600, lifting its market cap to nearly $200 billion.
However, the most significant gainers among the crypto leaders have been the Solana and MANA tokens, with the first gaining nearly 300% since bottoming at $8 on Dec. 29, 2022, currently trading at around $25, while the Metaverse-linked token more than doubled its price from the lows of $0.30 to the current highs of $0.70s in the same period.
The total cryptocurrency market capitalization reached its highest level in over two months this morning (Jan. 16) climbing toward the key $1 trillion mark. Bitcoin has nearly the 40% of the total market capitalization, followed by Ethereum with nearly 20%, Tether with 7%, and Binance token with 5%.
Despite the recent rebound, the total cryptocurrency market capitalization is still 50% below the $1.88 trillion crypto market cap seen before the Terra-Luna ecosystem collapsed in April 2022, and still 70% below the $3 trillion crypto market cap seen when Bitcoin topped at nearly 69,000 at early November 2021.
2022 had being a wild year for the crypto ecosystem driven by the bankruptcies of major players in the market beginning with the Terra/LUNA ecosystem in April and followed by the collapse of the FTX crypto exchange platform and its token FTT.
Japanese Yen has been extending Q4, 2022 substantial gains into the first trading sessions of January, surging to levels that haven’t been seen since last June amid weakness in the U.S. dollar and Treasury yields as investors bet for even smaller interest rate hikes by the Federal Reserve in 2023 and less hawkish rhetoric.
The USDJPY pair fell as low as ¥129.50 a dollar in Tuesday’s Asian trading session before recovering to near ¥130.40 during the European session.
The pair has been on a downtrend momentum since topping near ¥152 level on October 21, 2022, driven by a less hawkish tone by the Fed’s policymakers together with an unexpectedly hit of a more hawkish tone by the Bank of Japan in early December, which increased expectations that it could tighten its ultra-loose policy in 2023.
Forex traders will also have one eye on the minutes from the Fed’s December policy meeting, due to be published on Wednesday, looking for any signals on whether the central bank intends to slow its pace of interest rate hikes further this year.
Federal Reserve hiked interest rates by 50 basis points in December following four consecutive 75 basis point increases, and markets will be keen to gauge the likely trajectory of monetary policy in 2023.
U.S. policymakers are widely expected to hike interest rates by 25 basis points when they meet in February, amid increasing signs that U.S. inflation has peaked from summer 9% highs to lows of 7% last month, and robust U.S. macroeconomic and labor data.
Japanese Yen has posted some outsizing gains this week, climbing as high as ¥130 a dollar following the Bank of Japan’s decision to allow the 10-year bond yield to move in a wider band, which might be the first step towards a broader monetary policy normalization process in the country to curb the record-high inflation.
On Tuesday, the USD/JPY pair hit a four-month low of ¥130,50 after the widely unexpected decision of the BoJ to widen the range within which it allows yields on the benchmark 10-year government bonds to fluctuate, a potential sign that the central bank eventually intends to tighten policy amid rising inflation.
According to the announcement, the BoJ will allow its 10-year Japanese government yields to rise as much as 50 basis points, or 0.5%, up from a previous cap of 0.25%.
The unexpected move has shocked forex traders helping the Yen to recover significantly against major peers, as the ultra-dovish monetary policy stance by BoJ was one of the main catalysts of the Yen to hit a multi-decade low of ¥152 a dollar in mid-November 2022.
Some investors have already started reversing their bullish bets on the USD/JPY pair on worries the BoJ’s hawkish swing on monetary policy could indicate the start of a hawkish policy change, while some others are debating that the move is a one-off technical adjustment.
Adding to the above, BoJ Governor Kuroda said the move was needed to correct distortions in the yield curve after global bond pressures pushed Japanese government bonds higher, and the action shouldn’t be viewed as the beginning of a hawkish pivot.