Euro tumbles to one-month low as Fed rate hike bets dominate
- EUR/USD stays under pressure as the US Dollar strengthens ahead of this week’s Fed decision.
- Markets increasingly expect the Fed to raise borrowing costs on Wednesday.
- Rising Oil prices keep inflation risks elevated on both sides of the Atlantic.
EUR/USD trades under pressure on Monday, with the Euro (EUR) losing around 0.55% against the US Dollar (USD). The Greenback strengthens across the board as traders position for a possible Federal Reserve (Fed) interest rate hike at the September 15-16 monetary policy meeting. At the time of writing, EUR/USD trades around 1.1525, near its lowest level since August 13.
Expectations for tighter Fed policy gained traction after Friday’s US inflation report showed headline Consumer Price Index (CPI) rising 0.4% MoM in August, accelerating from 0.1% in July. Core CPI increased 0.3%, up from 0.2% and marking its fastest pace in four months. According to the CME FedWatch Tool, markets price in an 86% probability of a quarter-point rate increase, up from around 59.4% a week earlier.
The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades around 99.66, up roughly 0.58% on the day and at its highest level since September 3. Strategists at Scotiabank note that the firm tone in the USD ahead of the FOMC is consistent with derivatives market signals, pointing out that “in recent years, swaps pricing which indicated 70% or higher risk of a Fed rate move has been a near perfect indicator of a policy move, so dollar gains in response to swaps pricing is understandable.”
They caution, however, that “there are still some risk around the outlook,” stressing that the currency’s reaction will hinge on how the Fed delivers any change in policy. In their view, “an unchanged decision from the Fed would be a shock for markets and a clear negative for the USD,” while even a “dovish” hike “which does not obviously commit to additional moves would also likely weigh on the USD.”
Rising Oil prices are adding to inflation concerns and putting further pressure on the Fed to raise borrowing costs. West Texas Intermediate (WTI) Oil trades near the $100 mark, having gained more than 15% so far this month.
Elevated Oil prices have also complicated the Eurozone inflation outlook. Last week, the European Central Bank (ECB) delivered its second rate hike of the year, lifting the deposit facility rate to 2.50%. ECB Executive Board member Isabel Schnabel said on Monday that recent energy-price developments are “quite concerning,” while policymaker Yannis Stournaras said timely action reduces the risk of more painful rate increases later.
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.
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