Currency Markets Mirror Rate Hike Expectations

(RTTNews) - Currency market movements during the week spanning April 21 to 28 reflected the anxiety, hopes and expected divergence amidst the monetary policy reviews by key central banks viz Bank of Japan, Reserve Bank of Australia, Federal Reserve, European Central Bank and Bank of England.

The dovish narrative surrounding the Dollar, especially in the wake of an unprecedented crisis in the banking sector dragged down the Dollar Index, a measure of the Dollar's relative strength. Market perception that anticipated the European Central Bank and the Bank of England to be more hawkish than the Federal Reserve lifted the EUR/USD pair and the GBP/USD pair. Expectations of an extended pause by the Reserve Bank of Australia caused the Australian Dollar to weaken against the U.S. Dollar. Expectations that the Bank of Japan would stick on to its ultra-dovish stance which were confirmed before the end of the week, compounded the Yen's weakness, especially against the U.S. Dollar.

In the backdrop of expectations of a mid-year pause in rate hikes, the Dollar Index, a measure of the Dollar's strength against a basket of 6 currencies weakened 0.15 percent to 101.67, from 101.82 a week earlier. The U.S. Dollar was in back foot for most of the week, tethering the Dollar Index between 101.01 and 102.17.

Stronger than expected earnings from technology heavyweights tilted demand from safe haven Dollar to riskier assets. Weak GDP data that showed the American economy growing 1.1 percent in the first quarter, versus 2.6 percent in the previous quarter and expectations of a growth of 2 percent also reflected in the Dollar's weakness. The March PCE price index hovering near the consensus 0.3% month-on-month figure kept sentiment steady.

Fears of stubborn inflation in the Euro Area goading the ECB to a hawkish posture lifted the Euro around 0.30 percent to the Dollar in the week ended April 28. With even a 50-basis points rate hike not yet ruled out, the pair strengthened to 1.1020, from 1.0987 at the end of the previous week. The pair ranged between a high of 1.1096 touched on Wednesday and a low of 1.0962 touched on Friday.

The GBP/USD pair finished Friday's trading at 1.2572, versus 1.2430 at the end of the previous week, gaining 1.14 percent in a week's time. The week's trading range was between the low of 1.2386 touched on Tuesday and the high of 1.2585 touched on Friday. The pound sterling strengthened against the Dollar amidst expectations that the Bank of England would have to act hard to tame inflation that was still running in double digits. Latest data had shown inflation for the month of March at 10.1 percent versus 10.4 percent in the previous month and consensus expectation of 9.8 percent.

The AUD/USD pair depreciated 1.2 percent during the week spanning April 24-28, dropping to 0.6607 from 0.6690 at the end of the previous week. The pair touched a high of 0.6707 on Tuesday on which day, data showed annual inflation in Australia falling less than expected to 7 percent. Markets had expected CPI to cool to 6.9 percent, from 7.8 percent in the previous month. However, market expectations of an extended pause by the Reserve Bank of Australia dragged the pair to 0.6572 by Friday, before rebounding and finishing the week at 0.6607.

The USD/JPY pair gained around 1.6 percent during the week ended April 28, rising to 136.28, from 134.15 a week earlier. The Yen weakened amidst Bank of Japan in its meeting on Friday - the first under new Governor Kazuo Ueda - reiterating the continuation of its ultra-loose monetary policy stance. The yield curve control policy too was maintained. The USD/JPY pair ranged between a high of 136.57 and low of 133.01 during the week.

Whilst markets have taken a 25-basis point rate hike by the Fed on Wednesday as given, the Dollar's trajectory in the days to come would depend on the tone of Powell's guidance and how the Fed would try to strike a balance financial stability and price stability, going forward. Despite expectations that the Fed would be forced to be more dovish than its global peers, strong PMI data released on Monday has lifted the Dollar Index to 102.18 versus Friday's close of 101.67.

The Dollar's strength has also pressured the EUR/USD pair to drop to 1.0964 from 1.1020 on Friday. The ECB's decision would be known on Thursday and the ECB would invariably have to take cognizance of the tepid growth data from the Eurozone. Preliminary readings on Friday had shown the Eurozone economy grow at a less-than-expected 0.1 percent in the first quarter of 2023, after a flat fourth quarter.

Though the pound is not seen losing its momentum unless there is a dramatic dovish tilt to the policy guidance, fears of aggressiveness by the Fed have dragged the GBP/USD pair to 1.2480 versus 1.2572 on Friday.

The unexpected rate hike by the Reserve Bank of Australia has lifted the AUD/USD pair to 0.6695, from 0.6607 at the close of the previous week. Markets had expected the RBA to extend the pausing cycle.

The widening divergence between the ultra-dovish BoJ and the Fed has caused the USD/JPY pair to rise to 137.39, from 136.28 on Friday.

All eyes are now firmly on the Federal Reserve! It remains to be seen whether markets have accurately priced the Fed's tight balancing act between financial stability, price stability, growth and employment.