The Euro (EUR) licks its wounds against the US Dollar (USD) on Thursday, trading around 1.1380, near the lowest level of the last two months, after falling nearly 2% in less than two weeks. A strong US Purchasing Managers’ Index (PMI) report on Wednesday, higher US Treasury yields and the rebound in crude oil prices are posing a perfect storm for the Euro.
Preliminary US S&P PMI figures released on Wednesday showed that business activity grew at its strongest pace in more than five years, with jobs and wages rising fast and input prices surging amid higher energy costs,
These figures raised concerns that the US economy might be overheating, and provided additional reasons for the Federal Reserve (Fed) to tighten its monetary policy further in the coming months. Fed Governor Michael Barr confirmed those views later on Wednesday, assessing that “further rate hikes are likely needed to ensure timely return to the 2% inflation.”
Beyond that, a five-year US Treasury auction met poor demand on Wednesday, which sent yields surging to long-term highs. The yield for the benchmark 10-year note crossed above the critical 5% level to reach its highest levels in 19 years at 5.135%, increasing support for the US Dollar
Oil prices pose additional pressure on the Euro
If this was not enough, Oil prices have appreciated about 5% from Tuesday’s lows, with Brent Oil trading at $98.50 at the time of writing, drawing closer to the key $100 level and adding pressure on the Eurozone’s economic growth and inflation.
Analysts at Commerzbank expect this trend to extend as “strong economic performance in the US therefore continues to support the US dollar, at least for the coming weeks.” “Labor market report and US inflation figures for September, in particular, will be the focus of attention in the coming weeks,” say the Commerzbank experts, assessing that “unless these figures turn out to be unexpectedly weak, the market will likely maintain high expectations for the Fed, thereby continuing to support the US dollar.”
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.