The U.S. dollar continued to surge on Tuesday, driving the Japanese yen closer to a zone where intervention may be considered. While the yen is approaching 12-month lows against the dollar, both the euro and the British pound experienced declines to new multi-month lows versus the dollar.
The euro slipped below its previous low from January, which was at 1.0482. Europe’s shared currency had a challenging September, dropping 2.5% against the dollar. It is already down 1% in October following fresh signs of economic challenges in Europe. Analysts are increasingly warning that the euro may reach parity with the dollar in the coming months, especially if U.S. interest rates continue to remain elevated.
“It’s the feeling that the U.S. economy can stomach higher interest rates for a little bit longer. Implicitly it also means that the Fed might not be so quick to cut rates next year either,” said Bipan Rai, North America head of FX strategy at CIBC Capital Markets in Toronto.
Elsewhere, the Australian dollar also faced a setback, dropping to an 11-month low following the Reserve Bank of Australia’s (RBA) decision to keep interest rates unchanged.
Fed Prepares to Hike Again if Needed
The latest move higher in the greenback was fueled by robust U.S. economic data, which reinforced expectations that the Federal Reserve would maintain higher interest rates for an extended period. According to the Fed Rate Monitor Tool, the market is pricing in a 27% probability that the U.S. central bank will raise its benchmark rate at the upcoming FOMC meeting in November.
While the Fed has expressed a commitment to keeping monetary policy restrictive for some time to combat inflation, there are differing opinions among officials about the necessity of additional rate hikes this year.
Most recently, Fed Governor Michelle Bowman’s statement highlighted the ongoing debate within the Federal Reserve regarding the timing of future interest rate hikes.
“Inflation continues to be too high, and I expect it will likely be appropriate for the (Fed) to raise rates further and hold them at a restrictive level for some time,” Bowman said on Monday.
Bowman’s willingness to support a rate hike if inflation progress stalls or is deemed too slow suggests that there may be room for further tightening of monetary policy if economic conditions warrant it. This reflects the Fed’s data-dependent approach, where decisions on interest rates are based on incoming economic data and inflation trends.
Echoing Bowman’s statement, Cleveland Fed leader Loretta Mester also said the Fed’s work is likely not done.
“I suspect we may well need to raise the fed funds rate once more this year and then hold it there for some time as we accumulate more information on economic developments and assess the effects of the tightening in financial conditions that has already occurred,” Mester said in a speech in Cleveland.
On the other hand, Fed Vice Chair for Supervision Michael Barr also said on Monday he believes rates are now “at or very near” a sufficiently restrictive level.
Dollar Strength Here to Stay
New highs in the dollar come as the greenback reacts to the surging U.S. bond yields. Most recently, the U.S. government successfully avoided a shutdown, and economic data reaffirmed the belief that the Federal Reserve would maintain higher interest rates for an extended period.
Over the weekend, the U.S. Congress passed a stopgap funding bill with strong Democratic support, following a retreat by Republican House Speaker Kevin McCarthy from the earlier demands of his party’s hardliners for a partisan bill.
The avoidance of a government shutdown reduced demand for U.S. debt, and the data underscored the economy’s resilience despite the Federal Reserve’s target rate being in restrictive territory. Treasury yields climbed as a result, with the benchmark 10-year note reaching 4.703%.
“You are still seeing the U.S. growth story is much better than abroad and that is probably going to keep that interest rate differential widely in its favor,” said Edward Moya, senior market analyst at Oanda.
According to Carol Kong, economist and currency strategist at Commonwealth Bank of Australia, the selloff in U.S. Treasury bonds is currently a central topic in financial markets and it is expected to continue as long as U.S. economic data remains robust. The move higher in yields is also what is moving the dollar higher and stocks lower.
“(Tuesday’s) U.S. JOLTS job openings and non-farm payrolls on Friday can be a catalyst to push up U.S. yields and the USD if they surprise to the upside,” Kong said.
In September, U.S. manufacturing displayed further signs of recovery, with increased production and a rebound in employment.
The rally in the dollar has put further pressure on the yen, pushing it closer to the psychologically significant 150-level that markets view as a line in the sand for Japanese authorities that could spur intervention.
Japanese Finance Minister Shunichi Suzuki has stated that authorities are closely monitoring the currency market and are prepared to take action if necessary. He has also reiterated a warning against speculative moves in the currency market that do not align with economic fundamentals.
Wei Liang Chang, FX and Credit Strategist at DBS Bank, warned that the previous interventions by the Japanese government and the central bank had occurred around 150, signifying official discomfort when the JPY weakens beyond this point.
The yen weakness is not unexpected given the BoJ’s dovish stance compared to other central banks, especially since the Federal Reserve began raising interest rates aggressively in March 2022.
The BOJ’s September meeting revealed that more policymakers discussed the possibility of eventually exiting their ultra-loose monetary policy. Moreover, the BOJ announced plans to conduct additional bond-buying operations to curb a rise in yields after the benchmark hit its highest level in a decade.
USD/JPY is hovering just below the 150 mark after gaining 2.3% and 2.6% in August and September, respectively. The currency pair is now threatening to print fresh 33-year highs if it manages to clear the 2022 high printed in the 152 zone.
The U.S. dollar’s strength has spilled over into this week as well after the U.S. government successfully avoided a shutdown. Moreover, the economic data releases indicated continued strength in the U.S. economy while the Fed officials continue to warn that monetary policy will need to stay restrictive for “some time” to curb inflation as oil prices and labor prices continue to surge.