Euro tests two-week lows as risk aversion, Fed tightening bets buoy the US Dollar
- EUR/USD tests two-week lows at 1.1575 after rejection at the 1.1620 area on Tuesday.
- Rising hopes of Fed rate hikes and escalating tensions in the Middle East are boosting support for the US Dollar.
- ECB's Nagel said that "markets are pricing a 95% probability of a rate hike in September."
The Euro (EUR) is trading lower against the US Dollar (USD) for the second consecutive day on Wednesday, weighed by risk aversion amid growing tensions in the Middle East, while rising bets of Federal Reserve (Fed) interest rate hikes support speculative demand for the US Dollar. The EUR/USD pair trades at 1.1580, after being rejected at the 1.1620 area on Tuesday.
Geopolitical tensions are hurting investors' appetite for risk as reciprocal attacks between the US and Iran escalate, casting further doubt about a negotiated end of the war and pushing Crude Prices higher. Brent Oil trades at $94.00, nearly 7% up on the week, posing a significant challenge for the Eurozone’s economies as the increasing energy costs might dampen an already frail growth.
The US military launched a wave of strikes on Islamic Revolutionary Guard Corps (IRGC) targets across Iran, which were responded to with attacks on US bases in Bahrain, Jordan and Iraq, amid Tehran's accusations that the US bombings killed 18 civilians celebrating a wedding on Tuesday.
US data disappoints but fails to curb Fed tightening hopes
In the US, macroeconomic data disappointed on Tuesday. The US ISM Manufacturing Purchasing Managers Index (PMI) slowed down beyond expectations in August, with the prices paid sub-index flat and the employment gauge retreating from July’s high.
Beyond that, US JOLTS Job Openings increased below expectations in July. These figures, however, failed to dent hopes that the Federal Reserve will hike rates by a quarter percentage point at its September meeting. The CME Group’s FedWatch Tool shows a 68% chance of a rate hike later this month, nearly twice last week’s 36% rating.
In the Eurozone, data from Spain revealed that unemployment increased well beyond expectations in August and that the Italian Producer Prices Index accelerated in July. Also on Wednesday, the European Central Bank (ECB) Committee member, Joachim Nagel, affirmed that “markets see over 95% chance of a September rate hike”, yet with no visible impact on the Euro as that outcome has already been priced in.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.