Euro slides as strong US PMI data lifts Fed rate hike bets
- EUR/USD slides toward 1.1400 as strong US PMI data lifts the US Dollar.
- Traders raise their bets on an October Fed hike after the PMI release.
- ECB rate hike prospects offer the Euro little support for now.
EUR/USD extends its intraday decline on Wednesday as stronger-than-expected US business activity data reinforces expectations of another Federal Reserve (Fed) rate hike and lifts the US Dollar (USD). At the time of writing, the pair trades around 1.1401, near levels last seen in late July.
The preliminary S&P Global US Composite Purchasing Managers’ Index (PMI) rose to 58.4 in September from 56.0 in August. Manufacturing PMI climbed to 57.0, beating the 53.5 forecast, while Services PMI rose to 58.7 against expectations of 56.0. Both readings also improved from August. The survey showed a sharp rise in prices paid by businesses, adding to inflation concerns.
The US Dollar was already drawing buyers after the Fed raised rates by 25 basis points last week and signalled that another increase could follow as it works to bring inflation back to its 2% target. The strong PMI figures give policymakers more room to focus on inflation. The US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, trades around 101.00, its highest level since July 31.
Traders now see a 68% chance of a hike at the October meeting, up from 53% before the PMI release, according to the CME FedWatch Tool. Fed Governor Michael Barr added to the hawkish tone on Wednesday. Barr said US growth is strong and the labour market is solid, while inflation is not clearly moving back towards the 2% target. Barr added that more rate hikes would likely be needed to bring inflation down in a timely manner.
Eurozone PMI data released earlier on Wednesday also beat forecasts and remain in expansion territory, supporting the case for another European Central Bank (ECB) rate hike. ECB policymaker Joachim Nagel said rates are still in neutral territory and that a move into “mild restrictive territory” cannot be ruled out. “I am not relaxed, core inflation is still too high,” he said, though he has not seen significant second-round effects from higher Oil prices so far.
Middle East developments remain in focus. A senior Iranian official said reopening the Strait of Hormuz and lifting the US blockade were discussed during indirect talks with the US on Tuesday. Tehran is reviewing Washington’s response to its proposal to end hostilities.
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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