Welcome to another edition of Forex Friday, a weekly report in which we discuss selected currency themes mainly from a macro viewpoint, but we also throw in a pinch of technical analysis here and there.
In this week’s edition, we discuss the dollar, pound and euro, and look forward to the big central bank meetings in the week ahead.
Uneventful first half of Friday ahead of key macro events
The first half of Friday’s session has been uneventful, with traders sitting on their hands ahead of the release of US inflation and spending data in the afternoon, and major central bank decision in the week ahead. Backword-looking GDP data, which came out ahead of expectations on Thursday, failed to provide meaningful support for the dollar, as investors continue to price out the risks of further sharp rate hikes from the Fed. The path of least resistance thus remained to the downside for the dollar heading into the US session and ahead of the publication of Core PCE Price Index later on and monetary policy decisions from the Fed, ECB, and BoE in the week ahead.
USD/JPY holds below key resistance
The yen was the strongest currency following the release of hotter-than-expected inflation data from Japan overnight. The closely watched Tokyo Core CPI – a key leading indicator for the national inflation data released a few weeks later – jumped to +4.3% year-over-year, accelerating from +3.9% recorded in December. The USD/JPY held below the key 130.00-131.00 resistance range, as the data provided more reason for the Bank of Japan to alter its extra-ordinary loose monetary policy.
The USD/JPY will remain in focus later as the Fed’s favourite inflation measure is released at the same time as US personal spending and income, at 13:30 GMT. The Core PCE Price Index is seen rising +0.3% month-over-month with the year-over-year rate edging lower to 4.4% from 4.7% previously. At 15:50 GMT, we will have the latest pending home sales (seen falling 1.0% m/m) and revised figures for UoM’s Consumer Sentiment and Inflation Expectations surveys.
If the upcoming US data releases point to a weakening economy and abating inflationary pressures, then this should further weigh on the dollar as investors reduce their expectations of a hawkish surprise from the Fed.
The US dollar may also be held back because of the positive tone in the markets, after yesterday’s stronger GDP, jobless claims and durable goods orders all helped to keep the goldilocks scenario intact for the stock markets.
The big events are coming up next week when the Fed, BoE and ECB all meet to make their first policy decisions of the year.
EUR/USD consolidates gains ahead of FOMC and ECB
Once this week’s data releases are out of the way, the focus is going to turn to central banks in the week ahead. The Bank of Canada was the first major central bank this week to imply strongly that it will pause its aggressive rate hikes. This has raised hopes others will follow suit and thus we are near the peak in terms of interest rates. In turn, this could prevent a severe recession this year, something which the markets had been very worried about last year.
With both the Fed and ECB set to decide on monetary policy next week, the EUR/USD will clearly be a market to keep a close eye on. Given the ECB’s somewhat more hawkish remarks of late than the Fed, there is a stronger possibility we could see further short-term appreciation in the EUR/USD exchange rate in the short-term outlook. A run towards 1.10 cannot be ruled out, especially with the EUR/USD continuing to make higher highs and higher lows, with hardly and pullbacks. The technical trend is thus positive and momentum bullish. Any dovish surprises from the Fed or hawkish surprises from the ECB could see the bullish momentum accelerate. The EUR/USD bears meanwhile will need to see a clear reversal pattern in the EUR/USD before potentially looking to sell.
Which direction the EUR/USD takes from here will depend on whether the Fed or ECB will provide any major surprises next week. Let’s take a quick look at both…
Federal Reserve Policy Decision (Wednesday, Feb 1)
The Fed will kick off a busy week of central bank action on Wednesday. Signs of peak inflation has seen investors lower their expectations about the pace of tightening and the terminal interest rate. Risk assets have rallied as a result. But will the Fed throw a spanner in the works? The FOMC is expected to hike rates by a more standard 25 basis points following a 50-bps hike in December. Several Fed officials are thought to be backing a 25 bps hikes from now on, but what is not known is how long will they continue to hike before pausing. There remains some uncertainty about the terminal interest rate, and how long will the Fed hold a contractionary monetary policy stance.
European Central Bank Policy Decision (Thursday, Feb 2)
Several ECB officials have all but committed to raising the key rate by 0.5% to 2.5%, although policymakers have expressed different preferences for March. Thus, the market reaction on Thursday is likely to be about the future policy decision, especially after ECB President indicated there will be significant policy tightening at a “steady pace”. Will Christine Lagarde provide more clarity on this?
GBP/USD traders prepare for busy week
The GBP/USD has found some resistance near 1.2420 to 1.2450 range, forming what technically looks like a temporary top ahead of the FOMC and BoE policy decisions in the week ahead.
An already-split Monetary Policy Committee is unlikely to be unanimous as they consider whether to opt for 50 or 25 basis point hike. The markets are about 65% confident of a 50-bps hike owing to high underlying inflation, strong wage growth and unexpected resilience in the economy. Will the GBP/USD rise to 1.25 in the event of a 50-bps hike? It may already get there if the Fed, deciding on monetary policy the day before, provides a dovish surprise. If that’s the case, then the BoE’s decision might further fuel the rally.
But given that the exchange rate has already been appreciating, the bigger risk is if the Fed and/or BoE does not conform to market expectations. If the Fed is more hawkish or the BoE more dovish than expected, then this could see rates correct back towards 1.21 and possibly lower.