Currency Markets Encounter Rate Hike Turbulence

(RTTNews) - Three major central banks viz the Reserve Bank of Australia, the Federal Reserve and the European Central Bank undertook a review of monetary policy and interest rates during the week ended May 5. The outcomes were drastically different, ranging from an unexpected hike, an expected hike with hints of a pause and an expected hike with no hints of a pause.

Nevertheless, the turbulence that ensued gripped the wider currency markets. The Dollar weakened against the British pound, the Australian Dollar and the Japanese Yen whilst it held ground against the euro.

The Dollar mostly tracked the Fed, rising in anticipation of the Fed's announcement and falling in tandem with the hints of a pause. The Dollar Index or DXY which measures the Dollar's relative strength rose to 102.40 before the Fed's announcement but dropped all the way to 101.03 after the Fed hinted it was willing to end its rate hiking cycle. The affirmation that the Fed no longer "anticipates" further rate increases would be needed to tame inflation added to the bearish sentiment on the greenback.

The Fed hiked rates by 25 basis points but had also stated said that future rate action would be a lot dependent on incoming information including readings on labor market conditions. And then came the jobs data, rising unexpectedly. The U.S. economy which was expected to add 180 thousand jobs in April actually added a whopping 253 thousand, sharply higher than 165 thousand in March. Unemployment rate, which was seen rising to 3.6 percent from 3.5 percent in March actually dropped to 3.4 percent. The average hourly earnings which were expected to be steady at 0.3 percent also increased to 0.5 percent.

The Dollar gained as the solid jobs data renewed rate hike fears. The DXY finally ended the week at 101.21, shedding 0.44 percent from the closing level of 101.66 a week earlier.

The Euro received no major surprises from the ECB. The ECB continued to be aggressive and hawkish and also hiked rates by 25 basis points. The EUR/USD pair edged 0.03 percent lower during the week, falling from 1.1020 to 1.1017. The single currency's trading was within a tight band of 1.0941 to 1.1092.

The pound gained more than half a percent to the Dollar as the Fed's hints of a pause widened the divergence between the monetary policy stance of Bank of England. BoE is widely expected to raise rates by 25 basis points on Thursday as the economy grapples with double digit inflation. The GBP/USD pair finished the week's trading at 1.2641, versus 1.2572 at the end of the previous week after touching a high of 1.2653 and a low of 1.2435.

The Australian Dollar gained more than 2 percent to the U.S. Dollar as the Reserve Bank of Australia unexpectedly raised rates by 25 basis points whilst markets were hoping for an extended pause. From the low of 0.6604 touched on Monday, the AUD/USD pair strengthened to touch 0.6758 by Friday after the RBA warned that inflation remained high warranting more tightening albeit dependent on economic data. Inflation in the first quarter stood at 7 percent versus the RBA's target range of 2% to 3%. Over the course of the week, the pair surged to 0.6748. from 0.6607 at the end of the previous week.

The Japanese yen too gained around 1 percent to the Dollar, amidst the Fed's hints of a pause, boosted by a safe haven demand triggered by indications of fragility in the U.S. banking sector. Bank of Japan had in the previous week reiterated its ultra dovish monetary policy stance. The USD/JPY pair dropped 1.1 percent during the week to 134.83, from 136.28 a week earlier. The pair which had touched a high of 137.78 before the Fed's announcement touched a low of 133.50 over the course of the week.

The interest rate decision by the Bank of England is due on Thursday and the BoE is widely expected to raise rates by 25 basis points to combat double-digit inflation. Amidst these. The pound is now at $1.2584.

Before the BoE outlines its rate action, CPI readings from the U.S. for the month of April would be known. Headline inflation is seen steady at 5 percent whereas core inflation is seen edging down from 5.6 percent to 5.5 percent. Amidst these inflation expectations, the DXY which measures the Dollar's strength against a basket of 6 currencies has surged to 101.79, versus Friday's closing level of 101.21. The EUR/USD pair has decreased to 1.0945 whereas the AUD/USD pair is now at $0.6749. The USD/JPY pair is at 135.26.

With the Fed's guidance clearly declaring its dependence on data, uncertainty surrounding future monetary policy has only increased. Will the U.S. inflation readings chart currency market's trajectory? We would soon know!