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Market News Weekly foreign exchange review: Fed's sharp interest rate hike expectations cool, the dollar falls, the European Central Bank's eagle tone, the euro climbs

Weekly foreign exchange review: Fed's sharp interest rate hike expectations cool, the dollar falls, the European Central Bank's eagle tone, the euro climbs

The U.S. dollar index fell sharply in the week of May 27, and is set to decline for two consecutive weeks. The U.S. dollar index was lower, mainly because the U.S. Federal Reserve's sharp interest rate hike and cooling put pressure on the U.S. dollar. The occurrence of Fed officials dispelled the market's expectations for a substantial rate hike by the Fed, and the weak US economy also put pressure on the dollar. On the other hand, a hawkish tone from the European Central Bank boosted the euro, while a hawkish tone from the Bank of Canada also supported the commodity currency CAD.

2022-05-27
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The U.S. dollar index fell sharply on Friday (May 27) and is set to decline for two consecutive weeks. The U.S. dollar index was lower, mainly because the U.S. Federal Reserve's sharp interest rate hike and cooling put pressure on the U.S. dollar. The occurrence of Fed officials dispelled the market's expectations for a substantial rate hike by the Fed, and the weak US economy also put pressure on the dollar. On the other hand, a hawkish tone from the European Central Bank boosted the euro, while a hawkish tone from the Bank of Canada also supported the commodity currency CAD.

Next week, the market will be tested by a series of heavy data from the United States, including non-agricultural data. At the same time, many senior Federal Reserve officials will also deliver speeches. Focus events such as geopolitical situations and global epidemics are also worthy of continued attention. Next, let's take a detailed look at the trend of several major currency pairs this week.



The U.S. dollar index fluctuated and fell this week, mainly because the U.S. Federal Reserve raised interest rates sharply to cool down and put pressure on the U.S. dollar




Figure: US index daily chart trend

Fed officials dispelled market expectations for a substantial rate hike. A few days ago, the Federal Reserve pledged to keep raising interest rates until there is clear and convincing evidence that inflation is receding. Fed official George expects the policy rate to be close to 2% by August.

Federal Reserve Chairman Jerome Powell hinted that the central bank will raise interest rates by a full percentage point at its two meetings in June and July. Since then, the central bank's actions have become a key issue of debate among its policymakers. Powell was officially sworn in on Monday for a second four-year term; he was also sworn in as a new vice-chairman, Brainard, and two new directors, Jefferson and Cook.

Kansas Fed President Esther George said she expects the central bank to raise its target rate to around 2 percent by August, and further action will depend on the impact of supply and demand on inflation. "Fed policy makers have emphasized moving quickly to restore price stability," George said. "I expect that further rate hikes could bring the federal funds rate to around 2 percent by August, which is a significant rate of change in policy setting, inflation." Evidence of a clear deceleration will provide a basis for further tightening of the policy.

GMT+8 In the early morning of Thursday (26th), the Federal Reserve announced the minutes of its May policy meeting. The Federal Open Market Committee (FOMC) expressed its determination to suppress inflation, suggesting that it will raise interest rates by 50 basis points at the next two meetings, and interest rates may exceed the neutral level. However, as the policy tightened, officials at the meeting also focused on potential financial stability risks posed by volatility in commodity and government bond markets. The Fed next plans to reassess the economy by the end of the year to determine its next steps.

Weak U.S. economic data weighed on the dollar. Revised data released by the U.S. Commerce Department on Thursday showed that U.S. inflation-adjusted GDP (gross domestic product) shrank 1.5% quarter-on-quarter in the first quarter, instead of the 1.4% contraction reported in the initial value, which was also lower than expected. It shrank by 1.3%, turning negative for the first time since mid-2020.

Economists believe the data overstates the extent of the economic slowdown. The weakness in the economy stems largely from a record trade deficit as consumers open their wallets to buy foreign goods. In fact, consumer spending in the first quarter was revised up to 3.1%, up from an initial estimate of 2.7%. The downward revision to GDP was primarily due to weakness in inventories and household investment, with downward revisions in private inventories and residential investment offsetting upward revisions in consumer spending. Despite a solid expansion in consumer spending in the first quarter, the U.S. economy remains resilient.

U.S. consumers largely still expect the current inflation shock to be temporary and price gains to remain low and steady in the long run, according to a report from the New York Fed on Thursday. The survey confirmed earlier findings by the New York Fed showing that while short-term inflation expectations are rising, consumers expect prices to rise about 3 percent over five years. The researchers say this suggests they expect the recent surge in prices to fade over time.

While short-term inflation expectations continue to trend upward, medium-term inflation expectations appear to have plateaued over the past few months, while longer-term inflation expectations have remained markedly stable, the researchers said.

The Fed's preferred inflation measure, the Commerce Department's Personal Consumption Expenditure Price Index, is targeting a 2% annual rise. The measure rose 6.6% in the 12 months through March, while the Labor Department's consumer price index rose 8.3% in April. The report found that people are more divided on how prices will perform in the medium term, with an increase in the proportion of respondents who expect high inflation three years from now and the proportion who expect low inflation or even deflation.

Traders slashed expectations for Fed rate hikes. Traders this week downgraded expectations for further rate hikes by the Federal Reserve in 2022. Traders see a 60% chance that the target range for the federal funds rate will rise to 2.5%-2.75% by December, up from 35% a week ago, according to CME FedWatch data; but policymakers achieve 2.75%-3 by year-end The probability of the % target range fell to 27% from 51% on May 19.

The first-quarter GDP contraction was accompanied by the first drop in corporate profits in five quarters, which analysts believe suggests the economic contraction is more real than first thought after accounting for a record trade deficit.

Investors have been focused on how hard the Fed needs to tighten to bring down inflation at 40-year highs, while questioning whether the central bank will be forced to scale back in response to a possible economic slowdown.

The dollar hit a one-month low as traders lowered expectations for further rate hikes by the Federal Reserve, and is set for a second straight weekly decline this week. ING strategists said: The market's initial speculation that the Fed will pause its tightening cycle in September will certainly help the dollar weaken.

EUR/USD rebounded in shock this week, mainly due to the hawkish tone of the European Central Bank to the market




Chart: EUR/USD daily chart trend

On May 23 this week, European Central Bank President Lagarde said that the European Central Bank will raise interest rates at the monetary policy meeting held in July this year, and basically announced that the "era of negative interest rates" will end in September.

Lagarde's roadmap has won the support of many officials. On May 25, local time, ECB Deputy President de Guindos said the timetable was "very sensible", while ECB Chief Economist Len described it as "clear" and "strong policy".

The European Central Bank's governing committee and French central bank governor Villeroy also said that the European Central Bank must give priority to fighting high inflation, and successive interest rate hikes in July and September are basically a foregone conclusion.

The uncertainty of the situation in Ukraine at the end of February once made the European Central Bank "turn dove" again, but the February CPI data released in March once again made the ECB firm on the road of "turning eagle". The inflation rate of the euro zone in February increased from 5.1 in January. % surged to 5.8%. Lagarde made it clear that she was more concerned about high inflation than slowing economic growth.

At the interest rate meeting in March, the European Central Bank raised its inflation expectations again. It is expected that the average inflation rate in the euro area will be 5.1% this year, much higher than the 3.2% predicted in December last year; the average inflation rate in 2023 will be 2.1%, high Inflation fell to 1.9% in 2024, also higher than the previous forecast of 1.8%.

After that, inflation data in the euro area continued to rise. The April CPI announced on May 18 soared to a record high of 7.4% again. The ECB's mentality was completely "broken". You must know that in January last year, the CPI in the euro area also less than 1%.

As for inflation, which continues to soar, Villeroy said that inflation is high, almost four times the ECB's 2% target, and increasingly widespread, which is why we must normalize monetary policy.

The current European Central Bank deposit rate is -0.5%, and a 25 basis point interest rate hike in July is already "a certainty". It should be noted that the last time the European Central Bank raised interest rates dates back to 2011, when the two interest rate hikes came on the eve of the euro zone debt crisis.

In September this year, the European Central Bank is likely to raise interest rates again by at least 25 basis points, when the 10-year "negative interest rate era" will also come to an end.

However, in general, the European Central Bank is unlikely to raise interest rates aggressively, and a one-time rate hike of 50 basis points is still a small probability event. Villeroy said a 50 basis point rate hike was not part of the consensus under the current circumstances, and that rate hikes would be gradual.

GBP/USD rebounded in shock this week, mainly benefiting from a weaker dollar, but this week's rising expectations for a cautious Bank of England rate hike limited GBP's gains




Chart: GBP/USD daily chart trend

Manufacturing and services data from the UK this week were underwhelming. Analysts pointed to May data on services and manufacturing in the UK showing signs of a serious slowdown in the UK economy. Economic activity in the UK has all but stalled due to factors such as rising costs.

Some analysts even believe that the British economy will fall into negative growth in the second quarter. Inflation is likely to worsen as supply chains, labor shortages and other factors affect. The British economy is in a stagflation crisis, which also puts the Bank of England in a dilemma.

Huw Pill, chief economist at the Bank of England and a member of the Monetary Policy Committee, said the bank needs to tighten monetary policy further to deal with rising inflation, but also worries that too fast action will bring recession risks to the UK economy.

Pill, who has supported rate hikes at the Bank of England's previous four meetings, said he expects the Bank of England to take further action in the direction we forecast in the coming months. Under the influence of Brexit and the epidemic, more needs to be done for monetary policy to transition from supporting economic development to a state that may return to a financial crisis. We don't necessarily have to take an extremely tightening stance, but a stance that forgoes some easing and is more reflective of the fact that inflation is higher and the labor market is tightening.

The Bank of England is grappling with inflation, which is currently at a 40-year high and is expected to rise higher. In addition, the UK economy is expected to slow as people's living expenses are cut. That means that if the bank moves too slowly or too quickly, there is a corresponding risk, Pill said.

Speaking at an event hosted by the Bank of Austria on May 23, Bank of England Governor Bailey said the Bank of England is ready to raise rates again if data proves a need to raise interest rates, and policymakers need to ensure inflation is under control. The UK labour market is very tight, but that doesn't look like a fast-growing demand story.

The U.S. dollar fell sharply against the Canadian dollar this week, mainly due to a weaker U.S. dollar, but expectations of a substantial interest rate hike by the Bank of Canada and higher oil prices also supported the Canadian dollar




Chart: USD/CAD daily chart trend

In April, the Bank of Canada made a serious attack, raising interest rates by 50 basis points, doubling the benchmark interest rate from 0.5% to 1%.

Given that inflation is still high, the Bank of Canada will likely continue to "violently raise interest rates" next. The analysis pointed out that after the last time the Bank of Canada raised interest rates by 50 basis points, expectations for another 50 basis points of interest rate hikes at the next meeting on interest rates have risen sharply. ING expects the Bank of Canada to raise interest rates by another 50 basis points.

In the future, the Bank of Canada may even raise interest rates by 75 basis points at a time. Bank of Canada Governor Tiff Macklem (Tiff Macklem) said that the Bank of Canada is working hard to bring inflation down from a high level, and borrowing costs are likely to increase significantly in the future, not ruling out the possibility of a 75 basis point rate hike in the future sex.

The analysis pointed to a number of economic factors that could cause the Bank of Canada to suspend interest rate hikes after reaching the neutral rate, the most prominent of which may be real estate. Real estate plays an important role in Canada's inflation and economy, accounting for 30.03% of inflation, and housing-related industries account for more than 15% of GDP. After the big release of water since the epidemic in 2020, the disposable income of residents has increased, and then there has been a pursuit of anti-inflation assets.

On the other hand, considering that Canada is a major exporter of minerals and fuels, as commodity prices rise, it will have a positive impact on the export and sales of related industries, which will offset the negative impact of interest rate hikes to a certain extent. Overall, the Canadian economy will remain relatively stable, with GDP growth this year expected to be slightly lower than in 2021, and better than other developed economies.

The onset of the pandemic requires governments and central banks to work together to combat the loss of production, said David Dodge, a former Bank of Canada governor and senior adviser to Bennett Jones LLP. To that end, the Bank of Canada expanded its balance sheet and lowered interest rates. All of this happened in February 2020 until the end of 2020, very successfully averting an absolute catastrophe that could happen in Canada and around the world.

However, he said the central bank should have raised rates earlier. After 2020, things will get more difficult. We thought a year ago that the government would have to limit the amount of fiscal stimulus pouring into the economy and that the Bank of Canada would have to end its excessive easing and start raising rates by the end of last year. He added that rates should rise to the 2% to 3% range in 2021.

In addition, higher crude oil prices also supported the Canadian dollar this week. Oil prices were supported mainly by the arrival of the U.S. summer travel season. In the first three months of the year, drivers drove a 5.6 percent increase in miles driven, according to the AAA. About 39 million people are expected to drive 50 miles or more over Memorial Day weekend, an 8.3 percent increase from the same period last year and close to pre-pandemic miles, according to the data. A report from the U.S. Federal Highway Administration showed that car mileage hit an all-time high in April.

High-frequency data shows that traffic volumes have climbed over the past few weeks, showing more motorists on the road in places like the United States. Tighter gasoline and distillate markets are also adding a layer of bullish sentiment to the crude market, as record refinery margins are likely to boost refinery purchases this summer, analysts at TD Securities said. In this case, crude oil prices are likely to move higher again this summer despite concerns about the macroeconomic growth outlook.
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