Daily Market Pulse

Dollar muted amid Fed’s dovish outlook


On Tuesday, the U.S. dollar index remained above 102 as investors assessed the anticipated pace of Federal Reserve interest rate hikes against the backdrop of declining U.S. inflation and a weaker GDP forecast. Meanwhile, the dollar remained near its lowest levels in over seven months after data showed that U.S. annual inflation fell for the sixth consecutive month in December, to 6.5%, in line with market expectations. This was also the lowest reading since October 2021, boosting predictions that inflation reached 9.1% in June. The report confirmed predictions that the Fed would lift interest rates by 25 basis points in February, down from a half-percentage point increase in December. Meanwhile, weakening economic expectations left investors on edge, with the World Economic Forum, World Bank, and big U.S. corporations warning of a possible recession this year.


The Euro rose to its highest level in nine months early Monday before falling back and closing 0.07% weaker. Today, the Euro opened bullish on a weakening dollar and positive data releases. In January 2023, the ZEW Indicator of Economic Sentiment for the Eurozone increased by 40.3 points to 16.7, returning to positive territory for the first time since February 2022. In January, 43 percent of analysts polled forecast an increase in economic activity, 30.7 percent predicted no change, and 26.3 percent predicted a decline. Furthermore, the index of the current economic situation increased by 2.6 points to -54.8, while inflation expectations decreased by 4.4 points to 83.7. Traders are now looking forward to tomorrow's HICP index inflation data.


As all eyes focus on the UK's CPI report on Wednesday, the British Pound extended gains toward its best level since December 14th. Inflation is projected to decline further from its 41-year peak in October, but it is expected to remain considerably above the Bank of England's 2% target for some years. Meanwhile, investors have digested the latest jobs report, which revealed that the unemployment rate had remained close to a 50-year low. In other economic news, the Bank of England is expected to boost interest rates to 4% next month after nine straight increases. Markets are divided on how much further rates will rise after that, with the bank rate expected to peak at roughly 4.5% by the middle of this year.


The Japanese Yen fell today ahead of tomorrow's monetary policy decision by the Bank of Japan. The Nikkei 225 share index gained ground as the central bank's decision appeared to be hanging in the balance following a perceived tightening at its December conclave. At the meeting, they modified the yield curve control (YCC) program to target a 0.50%(+/-) band around zero for Japanese Government Bonds (JGBs) with maturities of up to ten years. They had previously set a target of +/- 0.25% around zero. Traders are wary as 10-year JGB rates continue to exceed the top limit of the BOJ's tolerance range. Investors expect wild moves in the Yen today and speculate that the BOJ will tweak its yield control strategy again this week.


Following the Canadian and U.S. job data, the Canadian dollar has recovered some of its losses lately. The unexpectedly strong domestic data suggested that the Bank of Canada may be a little more hawkish than previously anticipated. The Canadian currency is still supported by market expectations that the Fed will need to decrease interest rates before the end of the year, notwithstanding statements from various Fed members. Furthermore, the Bank of Canada's quarterly Business Outlook Survey hinted at the tone of the following monetary policy meeting. Traders are now looking forward to the release of the BOC CPI report later in the day.


The Mexican Peso was trading at a slight loss this morning after closing 0.07% lower against the U.S. dollar yesterday. Meanwhile, significant carry trade, particularly when adjusted for volatility, keeps the Peso as the favorite currency to hold in Latin America. Elsewhere, short-end swaps are expected to have a low volatility session due to the lack of trading in U.S. Treasuries. Short-end of TIEE curve prices in odds of Banxico slowing the pace of the tightening cycle in February after the bank hiked the benchmark rate by 50 basis points in December, following four straight increases of 75 basis points.


The offshore Yuan is down 0.66% against the dollar in today's session, dropping slightly from six-month highs as investors digested a slew of Chinese economic data. China's economy grew 2.9% year on year in the fourth quarter, down from 3.9% in the previous quarter but above expectations for a 1.8% increase. The country's most recent industrial production, retail sales, and fixed asset investment numbers were also stronger than expected, while the labor market improved. Meanwhile, full-year GDP growth in 2022 was at 3%, well below the official objective of 5.5%. A highly unpredictable recovery route for the world's second-largest economy is also a major concern for investors, with President Xi Jinping previously admitting that a quick exit from the zero-Covid policy may be unpleasant in the short term but beneficial in the long run.


On Tuesday, the Real advanced as investors weighed Chinese economic data, and the dollar remained subdued. Domestically, the economic agenda is empty, but the market is watching the participation of Finance Minister Fernando Haddad in the World Economic Forum in Davos. The minister announced yesterday that a new budgetary framework for the country should be provided by April. Investors are looking for new clues about the economy's trajectory. In the external situation, investors are looking forward to tomorrow's publication of data on producer inflation, retail sales, and industrial production in the United States.


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