Dollar Retreats from 20-Year High; FOMC Meeting Looms Large

The U.S. dollar edged lower in early European trade Tuesday, but remained near a 20-year high as traders prepared for the latest Federal Reserve meeting in the wake of a red-hot U.S. inflation report.

At 3 AM ET (0700 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.1% lower at 104.890, having climbed to a two-decade peak of 105.29 on Monday.

“Some rebound in risk assets over the coming days is possible given how fast risk assets have dropped in the past few sessions, and the dollar might face a correction soon, but at the same time, we think the FOMC rate announcement on Wednesday will prove mostly supportive for the greenback,” said analysts at ING, in a note.

The dollar’s recent gains follow the release of Friday’s May U.S. consumer price index, which soared to a new four-decade high of 8.6% on the year and caused traders to price in more aggressive rate hikes as the Federal Reserve struggles to cope with the unexpectedly hot inflation reading.

“The market’s reaction will be primarily driven by any clues about a potential deceleration in tightening in September, both through the updated dot plot projections and in Chair Jerome Powell’s press conference,” ING added.

The prospect of more hikes by the Federal Reserve in the near future has resulted in the 2-year Treasury yield climbing strongly, to currently stand at 3.3091%. The 10-year yield is below that, at 3.3050%, an inversion that is usually seen as a sign of an upcoming recession.

USD/JPY rose 0.1% 134.59, after hitting a 24-year low of 135.22 on Monday. The Bank of Japan expanded a round of bond purchases earlier Tuesday to keep the 10-year government bond yield near its 0.25% cap to try and boost a struggling economy.

The yen is the worst-performing major currency this year, down around 14%, as the BoJ keeps rates low while U.S. yields surge on bets for continued Federal Reserve hikes.

EUR/USD rose 0.4% to 1.0448, with the euro receiving a boost after German consumer prices in May rose 0.9% on a monthly basis, as inflationary pressure deepens on Europe’s largest economy.

The annual figure also jumped to 7.9% in May, up from 7.4% in the previous month, suggesting that the European Central Bank will face a challenge in its bid to control soaring inflation.

GBP/USD rose 0.4% to 1.2178, just above a two-year low despite the Bank of England being expected to deliver a 25 bp hike on Thursday.

The U.K. jobless rate rose in May as the number of people claiming unemployment benefits fell by less than expected, despite continued gains in overall employment levels. This, coupled with Monday’s fall in April GDP, suggests the BoE will struggle to tame soaring inflation without pushing the country’s economy into recession.

The risk-sensitive AUD/USD rose 0.6% to 0.6963, NZD/USD rose 0.5% to 0.6286, while USD/CNY fell 0.6% to 6.7176.