US Dollar plunges as Fed says disinflation now in play

Reuters: The US dollar plunges on Thursday after the U.S. Federal Reserve said it had turned a corner in the fight against inflation, giving markets a confidence boost that the end of its rate-hike campaign is near.

US Dollar plunges

Investors took a dovish cue from Fed Chair Jerome Powell’s remarks on Wednesday that “the disinflationary process has started” in the world’s largest economy, although he also signalled that interest rates would continue rising and that cuts were not in the offing. The Fed’s statement on Wednesday, which came after the conclusion of its two-day policy meeting where policymakers agreed to raise rates by 25 basis points, marked the central bank’s first explicit acknowledgment of slowing inflation. The dollar dived following Powell’s remarks, and against a basket of currencies, the U.S. dollar index fell to a fresh nine-month low of 100.80. It was last 0.12% down at 100.83, having fallen more than 1% on Wednesday.

“It was very much a sort of relief, that there was nothing there to really seriously challenge the market’s prevailing view,” said Ray Attrill, head of FX strategy at National Australia Bank. Powell said that rates are going to have to be restrictive for some time, but that doesn’t dissuade the market from saying some time might be six months, rather than two years.” The Aussie jumped to a new eight-month high of $0.7158 in early Asia trade on Thursday, after rallying 1.2% in the previous session. Against the Japanese yen, the dollar fell 0.55% to 128.21. The kiwi, which similarly jumped more than 1% on Wednesday, was last 0.25% higher at $0.6523. With the Fed out of the way, the stage is set for the European Central Bank and the Bank of England to announce their rate decisions later on Thursday, where expectations are for a 50bp hike from each.

The euro rose to a roughly 10-month peak of $1.1034 on Thursday, after gaining 1.2% in the previous session, while sterling was last 0.19% higher at $1.2399. “The risk is that we get a hawkish 50 from the ECB and a dovish 50 from the Bank of England, that might create some volatility,” said NAB’s Attrill. Euro zone inflation eased for the third straight month in January, data on Wednesday showed, but any relief for the ECB may be limited as underlying price growth held steady and concerns have already been raised about the reliability of the figures. “I don’t think that’s going to influence the messaging from the ECB, which I think is still going to be that they’ve got a lot to do,” Attrill said. In the United States, Friday’s nonfarm payrolls report will be the next test of the Fed’s fight against inflation, though Wednesday’s report showed that job openings unexpectedly rose in December, pointing to a still-tight labour market.

Markets are now expecting the Fed funds rate to peak just under 4.9% by June, compared with earlier expectations of a peak of just below 5%.

British Pound

Reuters: Sterling edged down versus the euro and held steady against the dollar on Wednesday as investors braced for major central bank meetings, including the Bank of England on Thursday. Investors closely watched the outcome of the Federal Reserve meeting while anticipating that the BoE tightening cycle would end soon with a 50-basis-point rate hike on Thursday and 25 bps in March. They will focus on the BoE Monetary Policy Committee’s updated economic projections, which might include an upward revision to the 2023 GDP forecasts due to more resilient domestic demand and lower energy prices. Most economists, when questioned, said the economic downturn was more likely to be shallower than they currently expect rather than deeper.

“A 25bp hike would be a fairly significant surprise for markets and, in our view, would likely trigger a rather sharp sell-off in the pound, regardless of how this is dressed up in the bank’s accompanying rhetoric,” said Matthew Ryan, head of strategy at Ebury. The pound was flat against the dollar at $1.2318. “The BoE decision might weigh on sterling if the BoE underdelivers and opts for a 25bp move only, as we expect,” Unicredit analysts said in a note. Sterling was down 0.2% versus the euro at 88.36 pence per euro. Some analysts reckoned there was little scope to push the euro higher even in case of a hawkish European Central Bank on Thursday, which means that a possible pound rally against the euro would be primarily a function of risk sentiment rather than monetary policy divergence.

“Since the pound tends to be more sensitive to global risk sentiment than the euro, the risks are skewed to the upside for EUR/GBP given our baseline scenario for a hawkish Fed weighing on risk assets,” said Francesco Pesole, forex strategist at ING. Britain is the only Group of Seven nation to have suffered a cut to its 2023 economic growth outlook in International Monetary Fund forecasts published on Tuesday. “It is far from certain whether it will turn out to be as bad as the IMF predicts or whether there will be a recession in other countries too, and whether weak UK growth really will turn into a long-term problem,” said Ulrich Leuchtmann, head of forex and commodity research at Commerzbank.

South African Rand

Reuters: South Africa’s rand strengthened against a weakened dollar on Wednesday as investors awaited the U.S. Federal Reserve’s interest rate decision, which could signal the end of its tightening cycle. At 1559 GMT, the rand traded at 17.1775 against the U.S. dollar, 1.22% stronger than its previous close. The dollar index, which measures the currency against six rivals, was down around 0.4% at 101.68. The Fed raised its target interest rate by 25 basis points, setting aside the rapid hikes used last year to curb a surge in inflation in favour of a more stepwise hunt for a stopping point. South Africa’s new vehicle sales rose 4.8% year-on-year in January, data showed on Wednesday, while separately the Absa Purchasing Managers’ Index remained in positive territory thanks to growth in business activity and inventories.

South Africa’s new vehicle sales rose 4.8% year-on-year in January, data showed on Wednesday, while separately the Absa Purchasing Managers’ Index remained in positive territory thanks to growth in business activity and inventories. On the Johannesburg Stock Exchange, the Top-40 and the broader all-share indexes closed around 0.4% higher. Among notable gainers, Bid Corporation jumped 6.57% after the food service firm said it expected its half year profit to rise as much as 49%. Harmony Gold closed 2.76% higher after the miner said improved metal grades at its underground mines during the second quarter helped it meet production targets and offset the impact of ongoing power cuts in South Africa and global supply chain disruptions.

The government’s benchmark 2030 bond was stronger in afternoon deals, with the yield down 7 basis points to 9.605%.

Global Markets

Reuters: Asian stocks jumped on Thursday while the dollar eased after Federal Reserve Chair Jerome Powell said a “disinflationary” process was underway, boosting risk appetite and hope that the U.S. central bank will soon end its monetary tightening streak. MSCI’s broadest index of Asia-Pacific shares outside Japan was 0.84% higher, while Japan’s Nikkei rose 0.37%. Australia’s S&P/ASX 200 index added 0.37%. Chinese stocks were 0.11% higher, while Hong Kong’s Hang Seng Index was up nearly 1%. The U.S. central bank announced an expected 25 basis points interest rate increase after a year of larger hikes and said it had turned a key corner in the fight against a high inflation rate. But policymakers projected “ongoing increases” in borrowing costs would still be needed.

Still, the market took a dovish cue from comments from Powell’s news conference. That helped the S&P 500 and the Nasdaq close sharply higher overnight. Ali Hassan, portfolio manager & managing director at Thornburg Investment Management, said Powell was seemingly shrugging off easier financial conditions as a concern in his news conference. “This was a greenlight that the market could buy without feeling that they are fighting the Fed.” The focus will now switch to European Central Bank and Bank of England meetings scheduled for Thursday and the interest rate path the two central banks are likely to take. Saxo Markets strategists said the ECB has surpassed its peers in the hawkishness quotient recently, and will likely repeat that this week. The BOE will likely be the trickiest given indecisive market pricing as well as the scope for a split vote, they said.

In the currency market, the dollar spiked lower following Powell’s remarks, with the U.S. dollar index, which measures the currency against six major peers, falling to a fresh nine-month low of 100.80. It was last at 100.98. The euro was up 0.2% to $1.1011. The yen strengthened 0.22% to 128.65 per dollar, while sterling was last trading at $1.2372, down 0.03% on the day. The yield on 10-year U.S. Treasury notes was up 1.5 basis point to 3.413%, while the yield on the 30-year Treasury bond was up 1.3 basis point to 3.563%. The two-year U.S. Treasury yield, which typically moves in step with interest rate expectations, was down 0.2 basis point at 4.108%. Spot gold added 0.2% to $1,953.69 an ounce, having touched nine-month high of $1,957 per ounce earlier.

U.S. crude rose 0.93% to $77.12 per barrel and Brent was at $83.48, up 0.77% on the day.

Published by the Mercury Team on 2 February 2023

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