Dollar Weakens As Fed Seen Slowing Down On Rate Hikes

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Currency markets were sober in the week January 23-27 amidst an anxious wait to the interest rate reviews by the Federal Reserve, Bank of England, European Central Bank and Reserve Bank of Australia due in the first week of February. Holidays in key Asian markets also influenced both sentiment and volumes.

Currency market movements during the week mostly hovered around the economic data releases and central bank news. Inflation reading for fourth quarter from Australia came in at 7.8 percent, higher than the expectations of 7.5 percent. As expected, Bank of Canada raised rates by 0.25 percent but surprised markets with a signaling of a pause, becoming the first major central bank to do so, in this hiking cycle.

GDP readings for the fourth quarter from the U.S. also threw a surprise reading of 2.9 percent, higher than the 2.6 percent that the markets were expecting. Finally, at the end of the week, data showed the Fed-preferred core PCE inflation dropping to an over one-year low of 4.4 percent, providing the Fed with sufficient headroom to ease its monetary policy. Personal spending in the U.S. also declined 0.2 percent versus expectations of a 0.1 percent decline, implying a slowing down in the economy.

The U.S. dollar weakened against the Euro, British pound and the Australian dollar but strengthened against the Japanese yen. The Dollar Index (DXY), which measures the U.S. dollar's strength against a basket of 6 currencies viz, Euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc declined from 102.01 on January 20 to 101.93 by January 27. DXY ranged between the high of 102.43 touched on Tuesday and the eight-month low of 101.50 touched on Thursday.

The U.S. dollar weakened against the euro during the course of the past week, supported by hawkish comments from the ECB. The EUR/USD pair which was at 1.0855 at the close of the previous week strengthened to 1.0867 by the end of the recent week. The pair touched a nine-month high of 1.0930 during the week. The low point for the week was 1.0834 touched on January 24.

The U.S. dollar weakened against the pound as well, with the GBP/USD pair edging up to 1.2397 by January 27, from the level of 1.2393 at the end of the previous week. The pound traded between a high of $1.2450 and a low of $1.2262 during the course of the week amidst expectations that the Bank of England would have to continue to be aggressive on rate hikes to tame the sticky inflation.

The higher-than-expected inflation readings in Australia lifted the Australian Dollar upon fears that the Reserve Bank of Australia would have to increase rates further to tame the persistent inflation. RBA's next interest rate decision is due on February 6. Sentiment was also buoyed by the reopening of the Chinese economy. The AUD/USD pair increased to 0.7103, from 0.6966 over the course of the past week. The pair ranged between a high of 0.7143 and a low of 0.6954 during the week.

The Bank of Japan's continuing easy monetary stance dragged the Japan yen lower. The USD/JPY pair increased from 129.57 on January 20 to 129.85 by January 27. The weekly trading range was between 131.12 and 129.02. Bank of Japan's next interest rate decision is due on March 9.

Impending monetary policy decisions by the Federal Reserve, Bank of England and the European Central Bank as well as the accompanying commentary would shape the currency market's trajectory over the course of this week.

The Fed is expected to raise rates by 25 basis points or even lower, whereas the ECB and BoE are seen handing down 50 basis-points hike. Based on current market expectations, the DXY is at 101.90, the EUR/USD is at 1.0884, GBP/USD is at 1.2373, AUD/USD is at 0.7071 and USD/JPY is at 130.22.

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