Investing.com – The U.S. dollar remained in demand in early European trade Tuesday, climbing to a five-month high, while sterling retreated after relatively benign wage data.

At 04:00 ET (09:00 GMT), the Dollar Index, which tracks the greenback against a basket of six other currencies, traded 0.1% higher at 106.125, just below the 106.39 level seen earlier Tuesday, the highest since the beginning of November. 

Retail sales push dollar even higher

The safe-haven dollar has been supported by a reduced risk appetite given the elevated tensions in the Middle East, as traders cautiously await Israel’s response to the Iranian strike over the weekend, amid fears of a wider regional conflict.

Additionally, Monday’s hot –up 0.7% last month, compared with an expected 0.3%–raised more questions about when the could begin cutting interest rates, following robust employment gains in March and a pick-up in consumer inflation.

“Consumption was meant to be the weak link in the U.S. economy,” said analysts at ING, in a note, “but the lack of slowdown in this segment very much supports the view that the Federal Reserve is in no rush to cut rates.”

, the president of the San Francisco Federal Reserve Bank, added to the growing feeling that the U.S. central bank will take its time with rate cuts.

She said on Monday, there is “no urgency” to cut with the economy and labor market strong, and inflation still above the Fed’s target of 2%.

The economic calendar today includes the release of data for March, as well as the latest readings of and , which will provide more insight into the health of the housing sector. 

But the main focus will be on an address by Fed Chair , due later in the session, for more cues on the path of interest rates and the U.S. economy. 

Sterling weakens after wage data

In Europe, drifted 0.1% lower to 1.2438, with sterling trading near a five-month low after data showed British grew by 6.0% in the three months to the end of February year-on-year.

This represented a drop from 6.1% the previous month, suggesting that wage growth may have topped, presenting the with an opportunity to cut interest rates if this continues.

BoE Governor said last month there had been “further encouraging signs that inflation is coming down,” but he also said the BoE needed more certainty that price pressures were fully under control before cutting.

fell 0.1% to 1.0615, near its weakest level since early November last year, continuing to weaken after the last week hinted at a rate cut in June. 

A cut in June would rely on no further setbacks in the geopolitical situation that affect energy prices and thus inflation, ECB policymaker Olli Rehn said on Tuesday.

Yen slumps to new 34-year low

In Asia, rose 0.2% to 154.55, rising to a new 34-year high above 154.

This recent weakness in the yen has occurred even as several Japanese government officials warned against excessive forex speculation, raising the possibility of intervention in currency markets.

Japanese Finance Minister Shunichi Suzuki said on Tuesday he was closely watching currency moves and will take a “thorough response as needed.”

edged higher to 7.2386, little moved even as data showed the economy grew more than expected in the first quarter.

But this was undermined by softer-than-expected and data for March, which suggested that momentum in the Chinese economy may already be slowing after a strong start to the year. 

The People’s Bank of China also set a weak midpoint for the yuan, indicating that the central bank has limited headroom to keep supporting the Chinese currency.

SHANGHAI (Reuters) – Chinese businesses are hoarding dollars because they expect their own currency to weaken, and that in turn is exacerbating a slide in the yuan that has been driven by wobbly stock markets and feeble growth in the world’s second largest economy.

This feedback loop has been playing out for months in mainland currency markets, spurred on by the dollar’s rising yield. Foreign exchange deposits have climbed $53.7 billion since September to $832.6 billion, People’s Bank of China (PBOC) data shows.

Analysts say one of two things needs to happen to end the downward spiral: the Federal Reserve needs to make deep rate cuts or the yuan needs to hit some form of a trough. Both seem distant.

is at five-month lows and has lost 1.9% to the dollar this year as foreign investors pull more money out of its struggling markets. The currency has fallen from around 6.7 per dollar at the start of 2023 to around 7.24 currently, a 5% drop.

Regular inflows from domestic exporters have dried up, as businesses choose to park their dollars offshore in deposits that earn them 6%, compared to 1.5% on yuan deposits at home, and just wait for better exchange rates.

Yu Zuochen, a director at Goertek Inc, a Chinese electronic equipment maker, told a forum in the coastal city of Ningbo in late March that exporters were “winning by lying flat”, referring to their foreign exchange gains.

“The rate differential between U.S. and China is the most positive since 2007, and I think this powerful fundamental fact is enough to explain why Chinese exporters are reluctant to exchange dollars for yuan,” said Alvin Tan, head of Asia FX strategy at RBC Capital Markets. “This huge positive yield spread is not evaporating anytime soon.”

Even for companies that choose to bring their dollars home, while authorities have capped dollar deposit rates at major lenders at 2.8% since the middle of last year, there are other dollar-based wealth-management products that invest in overseas funds offering as much as 4.4% for 7-day investments.

Becky Liu, head of China macro strategy at Standard Chartered (OTC:), says a “confirmation of the Fed rate cut including a clearer dollar softening trend” could be a catalyst for corporates to convert their foreign exchange into yuan.

However, if the recent string of robust inflation and economic data in the United States is anything to go by, Fed rate cuts are being pushed out to the end of 2024 and the dollar is on a tear.

That means it is more likely the yuan may hit 7.3, at which level exporters may bring dollars home, sensing authorities may shield it at that level. It was roughly the trough for the yuan in both October 2022 and July 2023.

Several investment banks also predict the yuan will weaken to 7.3 per dollar by the third quarter of this year, but no further. A Shanghai-based banker who deals with corporates said some of his clients are now eyeing 7.3 as the level to sell their dollars.

TERMS OF TRADE

Chinese authorities do not seem unduly perturbed by this accumulation of dollars by businesses and citizens. State banks that normally act on behalf of the People’s Bank of China (PBOC) have been buying the yuan to stem its slide.

The PBOC did not respond to a Reuters request for comments.

Lemon Zhang, a strategist at Barclays, says exporters’ “reluctance to convert their FX receipts will likely continue for the next two quarters”.

She does not expect Chinese regulators to force exporters to settle their FX receipts, but says there could instead be smaller macro prudential or tax relief measures to encourage conversion.

Despite the decline, the yuan has not fallen as far and fast as currencies of some of its trading partners, notably Japan whose yen is down 9% this year, which has eroded China’s trade competitiveness and dented its trade surplus.

China’s goods trade surplus fell 11% to $593.9 billion in 2023 from a year earlier.

Analysts at China Construction Bank (OTC:) estimate the FX settlement ratio, which measures conversion of export receipts to yuan, was just 51% in February as corporate clients placed dollars in deposits.

Investing.com– Most Asian currencies weakened on Tuesday, while the dollar rose to over five-month highs amid rising geopolitical tensions between Iran and Israel and increased bets on higher-for-longer U.S. interest rates. 

Stronger-than-expected Chinese gross domestic product data helped inspire some optimism towards Asia’s biggest economy, but the reading was offset by other middling economic indicators. 

Chinese yuan flat as Q1 GDP beats estimates 

The Chinese yuan moved little on Tuesday, with the pair hovering well over 7.2 even as data showed the economy grew more than expected in the first quarter.

But this was undermined by softer-than-expected and data for March, which suggested that momentum in the Chinese economy may already be slowing after a strong start to the year. 

The People’s Bank of China also set a weak midpoint for the yuan, given that the central bank has limited headroom to keep supporting the Chinese currency. The offshore yuan’s pair sank 0.2%, reflecting persistent selling biases towards the yuan.

While monetary stimulus measures are expected to help support the Chinese economy, they herald more weakness for the yuan in the coming months. 

Dollar at over 5-mth high as rate cut bets wane, Powell awaited 

The and rose 0.1% each in Asian trade, hitting their highest levels since early-November. The greenback’s latest gains came as U.S. data read hotter-than-expected for March, further underpinning inflation expectations. 

The retail sales data came just days after stronger-than-expected inflation readings for March saw traders largely price out bets on a June rate cut by the Federal Reserve.

Focus is now on an address by , due later on Tuesday, for more cues on the path of interest rates and the U.S. economy. 

Fears of higher-for-longer U.S. rates, coupled with weak risk appetite amid growing tensions in the Middle East, were a key weight on Asian currencies. Safe haven demand also saw traders largely favor the dollar.

The Australian dollar- usually seen as a key indicator of risk appetite, retreated on Tuesday, with the pair falling 0.4% to a five-month low.

The South Korean’s pair rose 0.9% to a 17-month high, while the Singapore dollar’s pair rose 0.3%.

The Indian rupee’s pair was close to record highs, trading well above the 83.5 level. 

Japanese yen on intervention watch as USDJPY hits 34-yr high 

The Japanese yen weakened further this week, with the pair rising to a new 34-year high above 154.

Recent weakness in the yen came even as several Japanese government officials warned against excessive forex speculation- a trend that is expected to spur intervention in currency markets.

This kept traders on guard for any potential intervention by the Japanese government, which usually entails selling high amounts of dollars to bring down the USDJPY pair.