Foreign exchange trading reminder: strong data support the Federal Reserve's interest rate hike in May, commodity currencies weakened, and the Bank of Japan is expected to maintain ultra-loose monetary policy this week

The U.S. dollar index edged up in early Asian trading on April 24, Beijing time, and is currently trading near 101.72. The dollar was little changed against major currencies on Friday as business activity data showed the world's largest economy remained resilient, supporting expectations that the Federal Reserve will raise interest rates by another 25 basis points at its policy meeting next month.

Data on Friday showed that the S & P Global US Composite Purchasing Managers' Index, which tracks manufacturing and services, rose to 53.5 at the start of the month, its highest level since May last year, from 52.3 in March. It was the third consecutive month that the PMI remained above 50, indicating private sector growth.

Karl Schamotta, chief market strategist at Corpay in Toronto, said: "Although economic activity is cooling, interest rate differentials still support the dollar and the US remains the cleanest dirty laundry on the global economic map."

Last Friday, after the data came out, the dollar rose by more than 40 points to 102.12, but the dollar index still closed down 0.09% on Friday at 101.71, recording a weekly gain of about 0.2%, the first time since the end of February.

However, the outlook for the dollar remains skewed to the downside as investors brace for the end of the Fed's tightening cycle, but Fed officials have been at pains to point out that inflation remains uncomfortably high and interest rates must continue to rise.

Money markets on Friday continued to show expectations for a 25 basis point US rate hike next month, which was positive for the dollar, before pausing in June. The interest rate futures market has also priced in a rate cut this year as the economy slows.

Juan Perez, head of trading at MonexUSA in Washington, said: "The Fed's rate hike message is no longer providing strong support for the dollar, and other currencies are also flowing as optimism for the second half of the world grows, not only to lower inflation but to avoid too much recessionary pressure."

The euro rallied from a low of 1.0937 against the dollar on Friday and finally closed up 0.24% at 1.099.

The pace of economic recovery in the eurozone accelerated unexpectedly in April as demand in the region's dominant services sector grew strongly enough to offset the impact of declining manufacturing.

Cyrusdela Rubia, chief economist at Commerzbank Hamburg, said the eurozone's purchasing managers' index showed a very benign picture of the overall economy, which was continuing to recover. However, a closer look reveals that the distribution of growth is very uneven. For example, the gap between a partly booming service sector on the one hand and a weak manufacturing sector on the other has widened further.

To meet growing demand, companies have increased their headcount at the fastest pace since May last year. The employment index rebounded to 54.7 in April from 53.3. Despite the high cost of living in the region, demand for services has improved as consumers continue to spend. The new business index rose to a one-year high of 55.8 from 54.2. But it was a different story for European Union manufacturers, which saw demand fall faster. Still, further improvements in supply chains meant raw material costs fell at the fastest rate in almost three years, so factories increased expenses only slightly. The output price index fell to 51.8 from 53.4, its lowest level since the end of 2020.

This is likely to be welcomed by ECB policymakers, who have been struggling to get inflation closer to their 2% target. Sources expect the ECB to raise interest rates for the seventh time in a row on May 4, with policymakers unanimously agreeing to raise rates by 25 basis points, even if a bigger move has not yet been ruled out.

On Friday, the pound fell as much as 0.54% against the dollar earlier, falling to a low of 1.2366 at one point, before recovering somewhat and finally closing up 0.01% at 1.2433.

UK inflation is tricky and the pound has been buoyed by a hawkish shift by the Bank of England. The higher-than-expected inflation data in March spurred the expected hawkish shift by the Bank of England, with money markets expecting a 25 basis point rate hike to 4.5% next month and another 25 basis point hike to 4.75% in June. By November, the Bank of England's benchmark interest rate will reach 5%.

The yen was one of the stronger performers early in the session on Friday, rising to a one-week high against the dollar after data showed that Japan's core consumer price index rose 3.1% in March from a year earlier, above the central bank's 2% target level, putting pressure on the Bank of Japan to abandon its ultra-loose monetary policy stance. The dollar closed down 0.07% against the yen on Friday at 134.13.

Kazuo Ueda, the new governor of the Bank of Japan, will chair his first policy meeting next week. Sources said the BoJ is likely to maintain dovish policy guidance and may discuss references on the impact of COVID-19 at its upcoming meeting. They believe the BoJ is likely to maintain ultra-loose monetary policy at this week's meeting without changing interest rate targets and yield allowance ranges.

Commodity currencies performed worse on Friday because on the one hand, New Zealand's inflation data was worse than expected, and New Zealand's interest rate hike expectations cooled. On the other hand, economic data from the United States, the United Kingdom, and the euro zone supported the prospect of further interest rate hikes. Interest rate differentials are expected to widen, and the prospect of interest rate hikes by European and American central banks also weighed on market risk-taking. The Australian dollar fell to 0.6677 against the U.S. dollar, a new low for more than a week, closing at 0.6692, a decline of about 0.71%; the New Zealand dollar against the U.S. dollar hit a new low since March 14 on Friday to 0.6125, closing down 0.53% to close at 0.6138.

Key data and events on Monday

Institutional Perspectives Summary

The Bank of Japan is likely to maintain ultra-low interest rates and a dovish index this week.

① The Bank of Japan is expected to maintain its ultra-loose monetary policy, including its interest rate target and the 0.5 per cent ceiling on 10-year government bond yields, at next week's rate review, according to four people familiar with the matter. Despite rising wages and building inflationary pressures, the BoJ is in no hurry to taper its stimulus measures, given the risk of slowing growth overseas and uncertainty over whether wage increases will be sustained next year, the sources said. "The BoJ can be patient in considering adjusting its yield curve controls as inflation has not yet consistently hit its target," one of the sources said;

② The BoJ is also likely not to make major changes to its forward guidance at next week's meeting, including a pledge to keep interest rates at "current or lower" levels, the sources said. But since Japan has already lifted COVID-19-related restrictions, the BoJ is likely to remove references to the impact of the epidemic in the coming months, most likely at its June meeting

2. Goldman Sachs is bearish on the dollar;

Goldman Sachs economists believe that the dollar is at a critical juncture in the face of the Federal Reserve's interest rate cut expectations, the looming risk of a recession, and the Fed's less dovish rhetoric.

② The dollar continued to weaken due to weak economic activity data, cooling inflation, and easing banking sector pressures

3. Bank of Montreal: If the spread narrows to support the pound, the pound could hit nearly 1.27 against the dollar this quarter.

The Bank of Montreal said the pound could hit a one-year high of nearly 1.27 against the dollar this quarter if interest rate spreads narrow to support the pound, but that forecast also carries risks.

Stephen Gallo, global foreign exchange strategist at Bank of Montreal, said that the Federal Reserve will soon pause, other central banks will catch up with the Federal Reserve, and interest rate spreads will narrow.