Weekly foreign exchange review: The Fed's sharp tightening expectations are rising, and the US index hits a new high in two decades this week

On Friday (April 29), the U.S. dollar index fluctuated and climbed, hitting a new high in nearly two decades. Although the U.S. GDP unexpectedly shrank in the first quarter, the market’s expectations for the Federal Reserve’s decision to raise interest rates sharply next week continued to rise, which supported the dollar.

In other non-U.S. areas, the euro fell against the U.S. dollar, and the geopolitical crisis in Europe put pressure on the euro. Sterling fell to a two-year low against the dollar as market expectations for a rate hike by the Bank of England cooled. The U.S. dollar against the Canadian dollar basically maintained volatile trading, and the Bank of Canada tightening expectations increased.

Next week, the market will usher in the much-anticipated Fed decision in May, and the US Labor Department will also release the non-farm payrolls report next Friday. In addition, there is the escalating geopolitical situation, which investors should pay close attention to. Next, let's take a detailed look at the trend of several major currency pairs this week.

The U.S. dollar index climbed volatilely this week, hitting a new high in two decades, mainly supported by expectations of a substantial rate hike by the Federal Reserve

Figure: US index daily chart trend

The U.S. dollar index, which measures the U.S. dollar against six major currencies, has risen significantly in recent days, with the U.S. dollar index, which measures the U.S. dollar against six major currencies, rose significantly in recent days, with the U.S. dollar index rising significantly this week, as the U.S. central bank has tightened monetary policy more strongly than most major economies’ central banks. It touched 103.94 in intraday trading, the highest since 2002.

Analysts expect the dollar to remain strong in the second quarter of this year due to the continued impact of the above factors. However, rising international commodity prices may support the currencies of relevant countries, and the U.S. dollar index may experience a correction when the Federal Reserve announces monetary policy in early May.

Data show that since the escalation of the conflict between Russia and Ukraine at the end of February this year, the US dollar index has increased by more than 7.5%, and the rate of increase has accelerated significantly since April. The exchange rate of the euro against the dollar has fallen by more than 7% this year, falling below 1 to 1.05 on the 28th. The exchange rate of the yen against the dollar has fallen by more than 13% since the escalation of the Ukraine crisis, falling to its lowest level since early 2002 on the 28th.

U.S. GDP shrank 1.4% in the first quarter this week, but limited impact on Fed rate hikes

On April 28, local time, data released by the U.S. Department of Commerce’s Bureau of Economic Analysis (BEA) showed that the U.S. real GDP fell by 1.4% year-on-year in the first quarter, lower than the market’s expected growth of 1.1%. The decline in real GDP in the first quarter reflected lower private inventory investment, exports, federal government spending, and state and local government spending, while imports rose, the BEA said.

In terms of items, in the first quarter, private inventory investment dragged down GDP by about 0.84 percentage points; exports fell by 5.9% month-on-month, dragging down GDP by about 0.68 percentage points; imports rose by 17.7% month-on-month, dragging down GDP by about 2.53 percentage points; government spending fell by 2.7% month-on-month , dragging down GDP by about 0.48 percentage points.

Also, the increase in consumption reflected an increase in services (led by healthcare), but was partially offset by a decrease in goods. Among commodities, decreases in nondurable goods (led by gasoline and other energy commodities) were partially offset by increases in durable goods (led by automobiles and parts). The increase in non-residential fixed investment reflects an increase in equipment and intellectual property products.

Cheng Shi, chief economist of ICBC International, said that the core reason for the U.S. GDP contraction in the first quarter was the supply shock caused by the repeated global epidemics. The sluggish U.S. foreign trade had a huge impact on the growth in the first quarter. It is worth noting that U.S. consumption is still strong, which It also means that the GDP contraction in the first quarter has not shaken the foundation of the US economic recovery.

Zhou Maohua, a macro researcher at the Financial Market Department of China Everbright Bank, said that in the first quarter, U.S. commodity sales were not satisfactory, mainly due to the withdrawal of unprecedented stimulus policies in the U.S., high prices, supply bottlenecks, fluctuations in energy and raw material commodity markets, the Fed’s tightening of financing conditions, and geopolitical conflicts. etc., which has obviously weakened the confidence of consumers and businesses, the growth of residents' wages has not kept up with the rise in prices, and the purchasing power of residents is declining.

Analysts from the research and development department of Oriental Jincheng said that the current level of domestic inflation in the United States is high, and some exporters find that domestic sales are more profitable, which may also be an important reason for the surge in the US trade deficit in the short term. In fact, high inflation and a sharp appreciation of the dollar have also attracted a lot of imports in the opposite direction.

Expectations of future Fed rate hikes continue to rise

The Fed has started its interest rate hike cycle since March. The market expects the Fed to raise interest rates by 50 basis points in the next three interest rate meetings; the Bank of Japan, which has less inflationary pressure, said on the 28th that it will continue to implement an ultra-loose monetary policy; the European Central Bank is subject to Affected by the conflict between Russia and Ukraine, there is no intention to quickly tighten monetary policy. The central bank's monetary policy of the major developed economies has been significantly differentiated, which has stimulated sharp fluctuations in the relevant currency exchange rates.

Analysis shows that GDP in the first quarter will have an impact on the pace of Fed rate hikes, and the probability of extreme situations (such as aggressive rate hikes) will be reduced, but the impact will be limited; the Fed's tightening direction and determination will not be shaken. The next interest rate hike and the start of the shrinking of the balance sheet will come as promised.

The analysis believes that from the perspective of the two major responsibilities of the Federal Reserve, the U.S. unemployment rate was 3.6% in March. Combined with other indicators, the U.S. job market is “overheated” to a certain extent; while the consumer price (CPI) has reached a 40-year historical high year-on-year, which is a huge challenge for residents. The impact of consumption is gradually emerging. In order to avoid prolonged high inflation, the Fed will not change its policy direction in the short term.

In the future, the prices of commodities such as oil prices will continue to rise sharply, lack of motivation, and gradually fall from high levels. In addition, the core CPI will continue to decline slowly, which will drive the overall inflation rate to a downward inflection point around the end of the second quarter. It is expected that by the end of the year, the US CPI is expected to fall back to around 6%.

Mark Heifer, global chief investment officer at UBS Wealth Management, said the dollar has generally strengthened against other currencies recently, and is expected to remain strong in the second quarter due to growing concerns about a slowdown in global economic growth. Japan and the Swiss National Bank continued to implement "dovish" monetary policies, causing traditional safe-haven currencies such as the Japanese yen and Swiss franc to underperform. In addition, the US economy is not greatly affected by Russian energy. If Russia's energy supply to European countries is interrupted, the dollar will appreciate against the euro. Hefer said whether the dollar will further strengthen or pull back in the second half of this year will largely depend on the performance of the global economy in the third quarter.

Analysts at the Global Research Department of Bank of America believe that the combination of factors such as the timing of the Fed raising interest rates again and the increase in macroeconomic downside risks have led to the recent rise in the dollar exchange rate.

Matt Simpson, a senior analyst at GAIN Group, said that in the next year, the Fed is expected to continue raising interest rates, the US federal funds rate may rise to 3%, and the 10-year Treasury bond yield may rise to 3.5%. At the same time, Japan's economic situation does not support the rise in interest rates, so the US-Japan interest rate gap is expected to further widen, and the yen exchange rate may continue to fall.

The euro fell sharply against the dollar this week to a five-year low, mainly weighed by a strong dollar, with European Central Bank tightening expectations capping losses

Chart: EUR/USD daily chart trend

European geopolitical tensions cast a shadow over Europe's economic outlook

The U.S. and its allies pledged to send more heavy weapons to Ukraine during talks at a German air base on Tuesday, ignoring threats from Moscow, which said U.S. and allied support for Kyiv could lead to nuclear war .

Reports emerged over the weekend that the EU was considering various "smart sanctions" that would do the most damage to Russia while minimizing the impact on the euro zone. In either case, the risk still leans toward greater disruption to Russian supplies, not less.

Russia will cut off gas supplies to Poland on Wednesday, signaling a major escalation in tensions between Moscow and European nations over a key energy supply issue. Russia's state-owned gas supplier Gazprom will stop energy supplies into Europe via Bulgaria from Wednesday, April 27, the report said. Earlier, Gazprom notified Polish gas supplier PGNIG that it would stop gas supplies from 8:00 CET on Wednesday. This comes amid a standoff between the two sides over Russia's demand to pay for gas in rubles.

The focus now turns to other European countries, notably Germany, which also relies heavily on Russian gas. The Italian government is closely monitoring the situation, although the assessment is that there is no immediate risk of cutting off Italian gas supplies, according to a person familiar with the matter.

Germany hopes to find a new "source of oil" to stop imports of Russian oil within days. Germany hopes to find new oil supply channels in the next few days to completely replace oil imports from Russia in order to cooperate with the EU's oil import ban on Russia, German Economy Minister Habeck said on a visit to Poland on Tuesday.

It has been more than two months since Russia launched a large-scale attack on Ukraine. As Victory Day approaches on May 9, Danske Bank economists believe that Russia may step up its offensive against Ukraine. We believe that Russia's apparent underperformance in conventional warfare increases their risk of resorting to tactical nuclear or chemical or biological weapons. Such action could prompt a more aggressive Western/NATO response, leading to an escalation.

We believe that the latest developments may pose an even greater risk that Russia may be looking for an excuse to expand its military operations to Moldova to increase pressure on southwestern Ukraine. In another recent twist, Germany reversed its previous decision not to send heavy weapons directly to Ukraine. Further military support and tougher sanctions on Ukraine are needed to deter a Russian aggression, and Germany's latest action underscores a sense of urgency that, in our view, also increases the risk of escalation.

European Central Bank rate hike expectations rise, limiting euro losses

ECB President Christine Lagarde said this week that if inflation remains high, it is possible to raise the ECB's guidance rate for the first time this summer.

According to the report, Lagarde pointed out: The mission of the European Central Bank is price stability. Annualised inflation in the euro zone hit a record 7.5% in March, well above the medium-term target of 2%. According to the schedule, a decision will be made at the last monetary policy meeting before the summer break on July 21.

The European Central Bank warned in its latest economic bulletin that the Russian-Ukrainian conflict is creating enormous economic uncertainty. The ECB also acknowledged that soaring energy costs were the main reason for a major misstep in recent inflation forecasts, which will remain high in the coming months due to the sharp rise in energy costs.

The European Central Bank pointed out that the Russian-Ukrainian conflict is having a lasting impact on the European economy. Conflict and associated uncertainty have severely impacted business and consumer confidence. Trade disruptions lead to shortages of new materials and inputs. Soaring energy and commodity prices are reducing demand and dampening production.

Economic growth in Europe will depend on how the Russian-Ukrainian conflict evolves, the impact of current sanctions and possible further steps in the future. Inflation will remain elevated in the coming months due to sharply rising energy costs.

The ECB pointed out that the euro zone economy is expected to remain weak in the first quarter of 2022, mainly due to the restrictions related to the epidemic. Several factors, including the crisis in Russia and Ukraine, also weighed on the euro zone economy.

Fiscal and monetary policy support remains critical in the current situation. The successful implementation of investment and reform programmes under the Next Generation EU Programme will accelerate the energy and green transition. This should help strengthen the euro area's long-term growth and resilience.

In terms of policy tightening, the European Central Bank reiterated that the size of its asset purchase program (APP) will decrease month by month over the next three months. The ECB noted that data received since its last meeting reinforced its expectation that net asset purchases under the Asset Purchase Programme (APP) should end in the third quarter, the calibration of which will depend on the data.

On the interest rate front, the ECB said any adjustments to key European rates would take place some time after the end of the Asset Purchase Programme (APP) and would be gradual. The Governing Council expects key European interest rates to remain at their current levels until inflation reaches 2% earlier at the end of its forecast range.

The ECB also acknowledged that soaring energy costs were the main cause of the central bank's recent major errors in inflation forecasts. Previously, there was a major deviation in the European Central Bank's inflation forecast. The CPI growth in the euro zone in the first quarter of this year was 2% higher than the central bank's forecast in December last year, the largest deviation in history.

Sterling fell to a two-year low against the dollar this week, weighed down by a strong dollar, while UK rate hike expectations cooled

Chart: GBP/USD daily chart trend

Sterling has been low since the Russian-Ukrainian conflict escalated. This week, the pound saw another wave of sharp losses, and the pound against the dollar has reached a new low since July 2020 and is close to the lowest point in nearly two years.

The main reason for the fall of the pound this round is mainly affected by the war situation in Russia and Ukraine. It is reported that the United States intends to allow Ukraine to join NATO, which once again exacerbated the deterioration of the situation in Russia and Ukraine. There is also a reduction in expectations for a rate hike by the Bank of England.

According to the latest reports, the money market has been lowering expectations for the scale of the Bank of England's interest rate hike. The market currently generally expects the Bank of England to raise interest rates by about 140 basis points by the end of the year, compared with 160 basis points on Friday. Separately, the latest data showed that the amount of UK government borrowing in the 2021/22 financial year was nearly 20% higher than expected.

The survey showed that the British public's inflation expectations fell in April after rising for several months. British public expectations for inflation fell in April after rising for several months, a survey showed. The Bank of England will take the survey into consideration when considering how quickly it needs to continue raising interest rates.

Meanwhile, optimism among British manufacturers is slipping at the fastest pace since the coronavirus pandemic, a survey on Monday showed, adding to fears that rising inflation is holding back economic growth.

Societe Generale's Kit Juckes believes any interest rate appeal of sterling could soon fade away. He predicted that the Bank of England will not raise rates by 150 basis points by the end of the year, as money markets are still predicting because the economy will not be able to bear it.

Nearly a quarter of Britons say it's more difficult to pay household bills, with more than 40% saying they won't be able to save money in the next 12 months, an official survey has revealed. This comes before regulated energy price increases take effect.

Retail sales unexpectedly fell 1.4% in March from February, and market research firm GfK said consumer confidence fell this month to near its lowest level since records began 50 years ago.

The International Monetary Fund said last week that Britain's economic growth next year is expected to be the weakest of any major economy except Russia, while Britain's inflation rate will be the highest in the G7.

This poses a "challenge" for the Bank of England, as Rabobank's Jane Foley said, adding that buying interest in sterling could fade quickly if recession fears intensify.

If the economic outlook for the pound looks bleak, the political outlook will only make the situation even bleaker as pressure mounts on Prime Minister Boris Johnson to resign.

Lawmakers have launched an investigation into whether he misled parliament into breaking lockdown rules during the pandemic, with calls for his resignation growing.

USD/CAD has basically maintained a volatile trend this week, and expectations of a substantial interest rate hike by the Bank of Canada have increased, offsetting some of the impact of a stronger USD

Chart: USD/CAD daily chart trend

Bank of Canada Governor Tiff Macklem said on Wednesday that Canada's economy is overheating, creating domestic inflationary pressures that need to raise interest rates to cool. Macklem said rates may need to be above the neutral rate range for some time to bring inflation back to target. The neutral rate is currently estimated to be between 2% and 3%.

It will be a delicate question, but we do need to raise interest rates to moderate spending growth and bring inflation back to target, he added. Earlier this month, the Bank of Canada raised interest rates by a rare 50 basis points, and Macklem suggested the Bank of Canada may consider another big hike at its June 1 meeting.

He reiterated that how high rates rise will depend on how the economy responds to rate hikes and the outlook for inflation. Asked if rates would go back to where they were decades ago, Macklem said: "We may have to be above neutral for a while to get inflation back to target, but it's only slightly above 2 or 3 % instead of 7% or 8%.

Some time ago, RBC, BMO, TD, and CIBC took turns to predict the rate hike of the Bank of Canada, so many people said that these banks were too pessimistic. But on April 26 this week, the Bank of Canada publicly stated at the Standing Committee that the Bank of Canada will adopt a neutral interest rate policy.

At the end of this round of interest rate hikes, the benchmark interest rate will be as high as 3%, while the previous highest forecast was 2.5%. 3% is higher than any agency's forecast. In contrast, previous forecasts by major commercial banks were moderate and conservative.

The Bank of Canada warned in the meeting report that adjusting the benchmark interest rate is a means rather than an end, and the problem to be solved by raising interest rates is high inflation. The central bank's monetary policy should be interpreted from the central bank's point of view, that is, the central bank should maintain an inflation target, not an interest rate target.

The analysis pointed out that the Bank of Canada will not stop raising interest rates unless it reduces the inflation rate to 2%; while the real inflation rate in Canada may rise to more than 8% with the fine-tuning of the calculation method next month. Therefore, even if the interest rate is raised by 3%, no one can guarantee that the high inflation rate will be suppressed, because this time inflation is not only due to the flooding of the Canadian dollar, but also many uncertain factors from other countries and regions. And the side effects of those factors must also be borne by the Bank of Canada.

NZD/USD tumbled this week, mainly affected by a strong dollar, but RBNZ's tightening expectations limited the NZD's decline

Chart: NZD/USD daily chart trend

In the middle of this month, the Reserve Bank of New Zealand's monetary board announced a 0.5 percentage point increase in interest rates, raising the official cash rate (OCR) from 1% to 1.5%, the largest rate hike in 22 years. The move far exceeded market expectations, with 15 of 20 economists polled expecting the Reserve Bank of New Zealand to raise rates by just 0.25 percentage points.

Given the highly uncertain global economic environment, bigger moves now also provide greater policy flexibility in the future. And this rate hike is earlier than originally planned, the RBNZ said: The committee agrees that their policy 'last regret' is to increase the OCR now, not later, to stop inflation expectations from rising...continue on rhythm Tightening monetary conditions is appropriate.

Standard Chartered pointed out that New Zealand's inflation data supports the hawkish remarks of the New Zealand Federal Reserve, and Federal Reserve Chairman Orr also expressed the hope that the official cash rate (OCR) will rise to neutral as soon as possible. The Reserve Bank of New Zealand is expected to raise interest rates ahead of schedule. After unexpectedly raising interest rates by 50 basis points in April, it is expected to increase interest rates by 50 basis points in May, and then raise interest rates by 25 basis points in July, and the official cash rate (OCR) will reach 2.25% by the end of the year.

New Zealand's first-quarter CPI was slightly lower than expected on Thursday, undermining expectations that the Federal Reserve will raise interest rates by another 50 basis points in May. However, inflation data still recorded the fastest pace of growth in 30 years, underscoring the need for the Fed to remain hawkish to curb upward price pressures.

"Uncertainty is high, but we still expect annual inflation of 7% in the second quarter of this year," economists at ASB Bank wrote in a note. For them, the bigger question is not when inflation will peak, but its sustainability, he added.

It's worth noting that the risk of a rate hike is that rapidly rising borrowing costs could bring the economy to a standstill, and New Zealand's house prices have already fallen during the pandemic.

Sharon Zollner, chief New Zealand economist at ANZ in Auckland, said: "With the housing market cooling faster than the RBNZ expected, over-steering the slowdown is a real risk...on the other hand, if Failure to do anything to address inflationary pressures that are far from target - which has yet to show any signs of shifting - will risk pushing up inflation expectations further, making the job (rate hikes) harder to keep inflation in check.