Weekly Wrap: Dollar soaring on back of hawkish Fed

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Written by Citadel Global Director, Bianca Botes.

Rising interest rates in the United States (US), coupled with the dollar’s status as a safe haven asset, has supported the currency throughout the year. This week has been no exception. On Monday and Tuesday, the US Federal Reserve’s hawkish testimony in Congress, saw the dollar rise to fresh three-month highs.

Key themes for this week include:

  • Dollar soars to three-month peak on the back of a hawkish Fed
  • Markets position for 50 basis point rate hike by Fed
  • South African GDP numbers undershoot expectations
  • Oil suffers 5% decline, gold near a two-month low, while steel trades near eight-month high
  • Rand feels the weight of the dollar

A CLOSER LOOK AT THE GREENBACK

The US dollar enjoys the status as the preferred safe-haven asset in times of rising interest rates. There are a number of reasons for this, which include:

  • The US has the largest and most liquid economy in the world, which means that the demand for dollars is always high.
  • The greenback is the primary reserve currency used by central banks around the world, which means that it’s widely accepted and used for international trade.
  • The US has a stable political environment with relatively predictable monetary and fiscal policies, which reduces the risk of sudden fluctuations in the value of the currency.
  • Finally, during times of economic and political uncertainty, investors often flock to safe haven assets, such as US Treasury bonds, which increases the demand for dollars and strengthens the currency’s value.

This week the dollar put on another stellar performance after Fed Chairman, Jerome Powell, testified before congress. His testimony was more hawkish than expected, and he reaffirmed that rates would need to increase more than initially anticipated, as the US economy’s resilience and a strong labour market have added to inflationary pressures. Without turning this Weekly Wrap into an economics 101 lecture, a brief review of why this is dollar positive can be summed up as follows: rising interest rates reduce the amount of money in circulation in an economy, resulting in the increase of value of each unit of currency.

On Tuesday, following Monday’s testimony, the dollar jumped a staggering 1.3%, which resulted in the US Dollar Index advancing 1.89% year-to-date, while gaining 7.66% over the past year. At the time of writing on Thursday, the dollar index held above 105.5, near its strongest levels in over three months, as Powell warned that the ultimate level of interest rates could be higher than anticipated in light of strong economic data, and that the Fed would be prepared to increase the pace of rate hikes if needed. Data released on Wednesday also indicated that US private employment rose more than expected in February, pointing to an ongoing tight labour market. Markets are currently expecting the Fed to raise interest rates by 50 basis points in March.

DATA IN A NUTSHELL

Retail trade in the euro area decreased by 2.3% in January, from a year earlier, following a 2.8% decline in December. The number of employed persons in the region rose by 0.3% quarter-on-quarter to 214.6 million in the three months leading to September 2022 – revised lower from preliminary estimates of 0.4% and rising at a steady rate from the third quarter’s value. Employment rose the most in Malta, Poland, Cyprus and Estonia.

New car registrations in the United Kingdom (UK) climbed by 26.2% from a year earlier to 74 441 units in February, accelerating from a 14.7% increase in the previous month. While February is typically a low volume month ahead of the March plate change, this year it marked the seventh month of consecutive growth as easing supply chain shortages steered the market closer to pre-pandemic levels. The month saw almost universal growth across the market, with deliveries to private buyers rising 5.8% and those to large fleets gaining 46.2%. Year-to-date, new car sales were up 18.6% to 206 435 units.

US new orders for manufactured goods dipped by 1.6% month-on-month in January, after a downwardly revised 1.7% climb in December, the reading, albeit a contraction, still beat market forecasts of a 1.8% decline. Orders for transportation tumbled 13.3%, dragged down by a 54.5% slump in those for non-defence aircraft and parts. Meanwhile, new orders for fabricated metal products climbed by 0.2%, while electrical equipment, appliances, and components saw an increase of 1.3%. The number of Americans filing for unemployment benefits fell by 2 000 from the previous week to 190 000 in the week ending 25 February, well below market expectations of 195 000. The latest value remained close to the nine-month low of 183 000, hit at the end of January, giving further evidence that the US labour market remains tight, in part due to reduced labour force participation. This could force employers to raise wages to attract and keep staff, adding to further inflationary pressure in the world’s largest economy.

South Africa’s economy advanced by 0.9% year-on-year in the fourth quarter of 2022, its smallest expansion in seven quarters, and well below market estimates of 2.2% growth, and after an upwardly revised 4.2% growth in the previous period. Output increased at a slower pace in activities such as transport, storage, communication, finance, real estate business services and agriculture. Meanwhile, the RMB/BER business confidence index in South Africa fell for the fourth consecutive quarter to a two-year low of 36 in the first quarter of 2023, pointing to a gloomy business outlook. RMB noted that the gauges tracking the sentiment of manufacturers and retailers slumped significantly in the quarter, leading to a decline in the overall index.

China’s annual inflation rate fell to 1% in February 2023 from 2.1% in the previous month, missing market forecasts of 1.9%. This was the lowest print since February 2022, with prices of both food and non-food slowing sharply, as consumers remain cautious, despite the removal of the country’s zero-COVID policy.

HAWKISH FED WEIGHS ON STOCKS

Stock futures contracts tied to the Dow Jones shed 0.1% on Thursday, while those linked to the S&P 500 and Nasdaq were down 0.3% and 0.6% respectively, with investors concerned over a resilient economy that will lead to a more aggressive tightening from the Fed. On the corporate side, ride hailing company, Uber, gained about 1% in premarket trading after Bloomberg reported that the company is considering a potential spin-off of its freight logistics unit.

London equities came under new pressure on Thursday, with the benchmark FTSE 100 falling below the 7 900 mark, dragged down by losses in the heavyweight materials sector. Risk appetite remains subdued in light of recent hawkish comments from the US Fed. Domestically, the British Chamber of Commerce forecasted that the UK economy would contract less than expected this year, likely avoiding a technical recession. Among single stocks, Endeavour Mining declined more than 9% to be among the top losers, while big miner, Rio Tinto, fell roughly 4%.

European equity markets traded in the red on Thursday, with the benchmark STOXX 600 dipping 0.4%, led by an over 1% loss in mining stocks. The German DAX was down 0.2%, with real estate firm LEG Immobilien plunging by over 10% after the company suspended its dividend following full-year results. In other corporate headlines, banker, Credit Suisse, announced that it will delay the publication of its 2022 annual report after a late call from the US Securities and Exchange Commission on Wednesday night. Meanwhile, investors continued to digest a hawkish US Fed. In Europe, Bank of France Governor, Francois Villeroy de Galhau, said the European Central Bank (ECB) will do what is needed to bring inflation back to it’s 2% goal.

The Japanese Nikkei 225 Index rose 0.63% while the broader TOPIX Index gained 0.97% on Thursday, hitting its highest levels in at least six months, as investors looked ahead to the Bank of Japan’s (BoJ’s) policy decision today. Investors also digested data showing Japan’s economy stagnated in the fourth quarter, highlighting a fragile economic recovery as private consumption remained subdued, which supports the case to maintain the BoJ’s massive stimulus. Notable gains were seen from index heavyweights such as Tokyo Electron, Nippon Steel, Sumitomo Mitsui, Toyota Motor and Shin-Etsu Chemical.

The JSE FTSE All Share index was down for a third straight session on Thursday, trading around the 77 520 level, as rate-hike worries persisted ahead of a crucial US jobs report due today. Interest-rate sensitive tech stocks were among the main laggards, followed by resource-linked sectors. Meanwhile, S&P Global Ratings, in an unscheduled announcement on Wednesday, lowered its outlook on South Africa’s junk-rated debt to stable from positive, citing the disastrous effects of load shedding on businesses across the country as one of the core reasons for the outlook change.

OIL SUFFERS STEEP DECLINES

West Texas Intermediate Crude futures held below $77/barrel on Thursday after shedding nearly 5% in the past two sessions, weighed down by expectations that the US Fed will tighten policy further to combat inflation, raising the risk of an economic slowdown that could dampen energy demand. Organization of the Petroleum Exporting Countries (OPEC) Secretary-General, Haitham Al-Ghais, also said weakening oil consumption in Europe and the US could threaten the market. Meanwhile, official data showed that US crude inventories unexpectedly fell by 1.7 million barrels last week, the first decline this year. Investors continue to assess the demand outlook in China, as the world’s top crude importer dismantled strict COVID-19 curbs but set a modest growth target for this year.

Gold held near $1 810/ounce on Thursday, trading close to its lowest levels in over two months, weighed down by hawkish remarks from the Fed Chair, as well as hotter than expected US employment data. Markets are currently expecting the Fed to raise interest rates by 50 basis points in March, which will increase the opportunity cost of holding non-yielding bullion.

Copper futures eased to $4.05/pound, to trade near two-month lows of $3.95/pound touched on 27 February as investors weighed the impact of monetary tightening and uncertain demand from China against supply worries. Robust economic data in the US and Europe magnified concerns that central banks would have to continue raising rates for longer, which will destroy demand. On the other hand, the Chinese government set a growth target of 5% for this year, during its National People’s Congress session. While this was a more modest rate than analysts expected, the government did confirm incoming stimulus for infrastructure and construction. Persistent supply concerns have, however buoyed prices, with mining deferments in Peru caused by political unrest, and ore processing operations in Panama having been put on hold due to government tax and royalty payments issues from Canada’s First Quantum Minerals.

Steel rebar futures rose to CN¥4 255/tonne, closing in on their highest levels in eight months, having been lifted by signs of tighter supply and optimism over an increase in Chinese demand. The measures are set to add to a wave of support received last year that propped up the vital Chinese property market, with home sales during February rising for the first time in 20 months. Signs of tight supply remained as major steel production hub, Tangshan, was forced to extend its production halt in response to heavy pollution.

CURRENCY VOLATILITY ENSUES AMID RATE OUTLOOKS

The euro depreciated to $1.05, its weakest level since 6 January, as investors turned to the dollar amid signs of potential acceleration in the pace of policy tightening from the US Fed. Elsewhere, traders have also digested hawkish remarks by a few ECB policymakers, with board member, Robert Holzmann, calling for four 50 basis point interest rate hikes at each of the ECB’s next four meetings, while ECB President, Christine Lagarde, stated that a 50 basis point hike in March was “very, very likely”. Data from last week showed the European Union’s inflation eased to 8.5% in February, above with the market consensus of 8.2%, while the core rate hit a fresh record high.

The British pound depreciated to $1.18, touching its weakest level since November 2022, as investors turned to the greenback following Jerome Powell’s hawkish remarks. The Bank of England is expected to increase interest rates by a further 25 basis points this month, before ending the current tightening cycle. The Central Bank has delivered 10 consecutive rate hikes since late 2021. Board member, Catherine Mann, warned on Tuesday that the pound could be vulnerable to the Fed’s and ECB’s hawkish outlooks.

The South African rand tumbled further towards R18.60/$, its weakest level since August 2020, as the dollar strengthened on Jerome Powell’s hawkish rhetoric. Local data showed a sharp contraction of South Africa’s GDP, putting further pressure on the already beleaguered rand. President Cyril Ramaphosa’s appointment of a new electricity minister, to solve the country’s power crisis, will also do little to restore investor confidence, according to analysts, who are anticipating that the South African Reserve Bank will either hold the interest rate this month, or only raise it by 25 basis points.

The rand is trading at R18.54/$, R19.62/€ and R22.11/£.