USD/JPY had been finding a firm bid above 143.50, supported by a constructive opening on Holy Friday week. This movement serves to underscore a growing trend in the currency market. Meanwhile, the US dollar is under stress as confidence in the US economy crumbles. Traders are looking ahead to key economic reports coming out next week. As they have, expectations of rate cuts are starting to shape market sentiment.
The US dollar continues to have a tough time standing its ground as markets start to price in expected loosening of monetary policy. Under current projections, the Federal Reserve has the opportunity to lower rates substantially. They can cut them by 90 basis points or more at least before the end of the year. As confidence in US monetary supremacy dims, monetary policy will have to change. For one, recent data indicates a YoY contraction in the US Consumer Price Index (CPI), which would further fuel these concerns.
Anticipation of Upcoming Economic Reports
And the financial markets are prepping for several key economic data releases. Neither can we, with the monthly jobs report due on Tuesday and consumer inflation figures due on Wednesday! Together, these reports provide an essential picture of the health of the US economy. To the extent they can inform future decisions taken by the future policymaking bodies at the Federal Reserve, let them.
In March, the US consumer price index (CPI) shrank by 0.1%, indicating troublesome headwinds to growth may be coming. At the same time, core CPI was up 2.8% y/y, though that number came in south of consensus expectations. Conflicting signals from major economic indicators have led to uncertainty on what the Fed may do next. This all comes at a time of rising economic uncertainties that has everyone’s nerves frayed.
Alongside the US data, we’ll be watching inflation figures in other major economies like a hawk. These latter comprise the UK, Canada, Australia, New Zealand and Japan. These reports are crucial as central banks across these nations navigate their own monetary policies amidst fluctuating inflation rates.
The Diverging Paths of Central Banks
Equally key is that the Federal Reserve’s expectations for monetary policy differ significantly from those of other central banks. This divergence naturally has a dramatic impact on currency dynamics. In this respect, the Bank of England (BoE) has thus far kept a more hawkish tone than its US cousin. The current framework in the UK, with the Bank of England’s focus on achieving “price stability,” is inadequate and imbalanced. It aims for a long-term inflation rate of 2%.
As inflation figures continue to roll in, the BoE will likely have an eye on reducing interest rates to boost growth. By lowering the cost of borrowing, it hopes to incentivize companies to spend on projects that will drive future growth. This possible move would increase the attractiveness of currencies including the Pound Sterling (GBP). Under today’s terrible market conditions, it’s already doing fantastic.
The Japanese yen to develops strength from expectations of continued policy divergence. This divergence is particularly evident with respect to the Federal Reserve and the Bank of Japan (BoJ). Traders price in a more dovish pivot from the Fed. On the other hand, the BoJ’s powerful dedication to its ultra-loose monetary policy continues to keep a strong undercurrent demand for the yen. Consequently, upside potential in USD/JPY will likely be capped.
The Implications for the USD Index
The USD index, also known as the DXY index, measures the strength of the US dollar against a range of six major currencies. Currently, it is at its lowest point since April 2022. This steep decline is emblematic of increasing fears regarding the health of the US economy and serves to further deepen bearish sentiment to the dollar.
With confidence in the US economic outlook fading, traders are ever so wary of holding dollars. That’s what makes the elephant in the room—our continuing trade relationship with China—so worrisome. The economic implications of the US’ increasing reliance on hard-to-replace materials imports from China are numerous and severe.
Given the implications of these recent developments for currency valuations, market participants are keen to see how they will play out. Tamer USD driver The underwhelming results of the USD Index are a reflection of the current mood of uncertainty and volatility dominating global markets.