The U.S. dollar has been moving upward against the euro and yen. There have been several factors involved, but the primary driver has been the Federal Reserve’s move away from accommodation well ahead of the European Central Bank (or ECB) and the Bank of Japan. Now, there are signs the ECB may move next.
Seeing U.S. consumer price inflation soar over 8%, the Fed has commenced raising rates and will soon start shrinking its balance sheet. Federal funds futures currently suggest a very rapid pace of rate hikes in 2022, ending up around 3% to 3.5% in the first half of 2023, at which time the Fed may take a pause.
Euro area inflation is now over 7%, yet the ECB still has its short-term target deposit rate at a negative half percent. Recently, several ECB board members have indicated they are ready to raise the target rate to zero. That is a small move relative to what the Fed is planning, but getting back to zero is a first step toward responding to the elevated inflation environment.
Japan inflation is only running about 1%, but signs are pointing that more inflation might be coming. For now, the Bank of Japan remains committed to near-zero rates across the maturity spectrum. The Bank of Japan controls both short-term rates and actively has a yield curve control policy to influence the Japanese Government 10-Year Bond. This is reflected as a large gap opening up among 10-year yields, with the U.S. the highest, German government bonds in the middle, and Japan bringing up the rear.
While inflation is driving the policy shifts at these central banks, the currency moves will be a cause for discussion. The challenge for the Bank of Japan, as it may develop for the ECB, is how much currency depreciation to tolerate. So far, the Bank of Japan is happy to stay put on the near-zero-rates policy and accept currency depreciation while other central banks, facing higher inflation, start to make their moves.
OpenMarkets is an online magazine and blog focused on global markets and economic trends. It combines feature articles, news briefs and videos with contributions from leaders in business, finance and economics in an interactive forum designed to foster conversation around the issues and ideas shaping our industry.
All examples are hypothetical interpretations of situations and are used for explanation purposes only. The views expressed in OpenMarkets articles reflect solely those of their respective authors and not necessarily those of CME Group or its affiliated institutions. OpenMarkets and the information herein should not be considered investment advice or the results of actual market experience. Neither futures trading nor swaps trading are suitable for all investors, and each involves the risk of loss. Swaps trading should only be undertaken by investors who are Eligible Contract Participants (ECPs) within the meaning of Section 1a(18) of the Commodity Exchange Act. Futures and swaps each are leveraged investments and, because only a percentage of a contract’s value is required to trade, it is possible to lose more than the amount of money deposited for either a futures or swaps position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles and only a portion of those funds should be devoted to any one trade because traders cannot expect to profit on every trade. BrokerTec Americas LLC (“BAL”) is a registered broker-dealer with the U.S. Securities and Exchange Commission, is a member of the Financial Industry Regulatory Authority, Inc. (www.FINRA.org), and is a member of the Securities Investor Protection Corporation (www.SIPC.org). BAL does not provide services to private or retail customers.. In the United Kingdom, BrokerTec Europe Limited is authorised and regulated by the Financial Conduct Authority. CME Amsterdam B.V. is regulated in the Netherlands by the Dutch Authority for the Financial Markets (AFM) (www.AFM.nl). CME Investment Firm B.V. is also incorporated in the Netherlands and regulated by the Dutch Authority for the Financial Markets (AFM), as well as the Central Bank of the Netherlands (DNB).
