The greenback started the new week on a positive note, strengthening against the euro by more than 0.6%. Yesterday, the USD index was able to develop a rebound from the strong support noted in the area of 97.70 last Wednesday, and reached a weekly high just above 99.00. Meanwhile, the EUR/USD pair fell for the third consecutive day yesterday, falling below the 1.1000 mark. Investors continued to win back Friday's data on the US labor market, which outlined an overall favorable picture of employment in the country and increased the chances of a more aggressive tightening of the Federal Reserve's policy.
Investors continued to win back Friday's data on the US labor market, which outlined an overall favorable picture of employment in the country and increased the chances of a more aggressive tightening of the Federal Reserve's policy. Futures for the federal funds rate put in quotes a 74% probability of a 50 basis point rate hike in May. More and more representatives of the Fed are hinting that this would be the right step.
San Francisco Fed President Mary Daly spoke in favor of such a decision on Friday, pointing to an increase in the probability of a 0.5% rate hike in May, citing a strong labor market and high inflation. A similar opinion is shared by the head of the St. Louis Federal Reserve, James Bullard, who last week repeated his call for an accelerated tightening of the monetary policy. "The labor market has recovered from the pandemic in almost all directions, and in several indicators it has completely exceeded the pre-crisis level. Moreover, inflation significantly exceeds the 2% mark, which the FOMC considers to be the level of price stability," said Bullard. The number of people employed in the US economy has reached 150.9 million people – against the February 2020 peak of 152.5 million people. At the same time, unemployment fell to 3.6%, returning to the pre-pandemic level.
According to the calculations of Bullard, the average value of the basic price index of personal consumption expenditures in the period from 2019 to 2023 will be 2.9%. "If the Fed does not take decisive measures to raise interest rates and reduce the volume of bonds on the balance sheet, it risks losing confidence in its policy regarding the 2 percent inflation target," he said.
Friday's data on the US labor market spurred expectations that the Fed will press harder on the brakes of monetary policy. However, these expectations are countered by optimism that a strong labor market will allow the economy to avoid recession by providing a "soft landing". Morgan Stanley strategists doubt such an outcome. They named a number of reasons why hopes for a "soft landing" may not be justified. These include an overbought stock market, underestimation of the consequences of the collapse of the Fed's bond portfolio and an inappropriate belief that the central bank will protect stock market investors from the consequences of policy tightening. U.S. stocks rebounded in March, reducing their quarterly losses. The S&P 500 index falls short of January highs of about 5%.
Investors are shifting capital from bonds to stocks, fearing to be left without assets during a period of high inflation, which outweighs other fears and against which real yields are now in deeply negative territory. Although market participants have started looking for sources of more generous remuneration, Morgan Stanley analysts advise looking for protection in bonds and selling stocks on the rally that is being observed now, since this growth lacks fundamental support. "There are all signs of a bear market rally. The shares are oversold. We assess the prospects of bonds more constructively than stocks on the short–term horizon, as questions about economic growth come to the fore – hence our strengthening of the defensive view," Morgan Stanley analysts said. They believe that the US economy is heading for a sharp slowdown, which will reflect a reduction in consumer demand due to the completion of fiscal stimulus last year, as well as due to rising prices, including food and energy prices. Investors will find it increasingly difficult to ignore this less favorable macroeconomic background, as it eats up corporate profits, say Morgan Stanley analysts, who do not believe in continued growth in the US stock market and expect the S&P 500 index to fall by at least 13%.
JPMorgan Chase Chief Executive Officer Jamie Dimon said yesterday that the American economy is facing unprecedented risks that force us to prepare for dramatic shocks. According to him, the situation in Ukraine can stimulate the growth of inflation, which will slow down the recovery after the pandemic and change global alliances for decades to come. "These factors introduce into the world completely different circumstances from those we have faced in the past, and their merger can significantly increase the risks in the future. Although it is possible and there is hope that all these events will have a peaceful resolution, we must be prepared for possible negative consequences," Dimon said. "Looking back, we can say that there were probably too many drugs and they were used for too long," he added, referring to the pandemic–era stimulus measures that kept consumers afloat and the cost of loans was low. Dimon also warned that the Fed could raise interest rates significantly higher than markets expect.
"This process will cause a lot of concerns and high volatility of the markets," he believes. Many analysts are inclined to believe that the Fed will accelerate the procedure for raising interest rates. Against this background, an event occurred that all financial markets are afraid of, namely, the inversion of the yield curve of US government bonds. The yield of 2-year treasuries exceeded the rate on 10-year securities for three consecutive trading days. On Monday, the yield of "two-year-olds" fell by one basis point to 2.42%, which still turned out to be more than the rate on 10-year bonds at 2.41%. An important feature of this indicator is that it looks to the future, not to the present, and signals an impending recession. An inversion can be separated from an actual recession by two years, during which a lot can happen. In addition, the yield inversion is an inaccurate indicator, especially in a situation when the Fed buys bonds, and price signals are distorted due to other interference. Thus, this event only calls for caution, and fears that a sharp increase in rates could undermine the recovery in the United States may be premature.
"The key event this week will be the publication of the minutes from the March meeting of the US central bank on Wednesday, and the market will carefully study this document to understand how hawkish the mood of the central bank has become," Sevens Report Research analysts said. If the Fed signals its readiness to start reducing the volume of assets on the balance sheet in the near future, this could become a negative factor for stocks, they noted. US stock indexes are trading in the red zone on Tuesday due to the continuing uncertainty about how sharp the further tightening of the Fed's monetary policy will be. In particular, the S&P 500 is losing about 0.6%. Meanwhile, the prospects for a further increase in the key interest rate are positive for the US currency. Reflecting the decline in risk appetite, the greenback stays close to weekly peaks around 99.00, leaving the EUR/USD pair under pressure. Credit Suisse strategists believe that the USD index retains the potential for growth to the top of the five–year range at 102.00-102.50.
"The key support is located at 98.73, which should keep the index from falling so that it can return to 99.42, and then continue moving to 100.00-100.04, and eventually to the top of the five-year range at 102.00-102.50. On the other hand, a break below 98.73–98.42 will lead to the designation of a short–term peak and indicate that the US dollar may roll back down, as a result of which support at 98.26 and at 96.05–96.00 will come into play," they noted. The Commonwealth Bank of Australia believes that the dollar exchange rate is close to peak values in relation to major currencies, since the quotes already contain expectations of a sharp tightening of the Fed's monetary policy. "Negative news from the geopolitical front or a further increase in energy prices may lead to the fact that the EUR/USD pair will test the level of 1.0800," CBA experts said. "Meanwhile, an improvement in market sentiment or a weakening of the dollar after the release of the Fed minutes may push the EUR/USD pair to resistance at 1.1150," they added, referring to the minutes from the March FOMC meeting, which is due to be published on Wednesday. While the US economy is in pretty good shape, the eurozone economy is experiencing big problems due to the Ukrainian crisis.
According to the results of a Sentix survey, investor morale in the currency bloc fell to its lowest level in almost two years in April. The indicator was -18 points compared to -7 points in March. The Russian-Ukrainian conflict and related sanctions are pushing the eurozone economy into recession, Sentix analysts believe. "Investors do not expect the eurozone central bank to rush to the rescue with a softer and more expansive monetary policy due to the still significant inflation growth rates. Although morale is falling all over the world, nowhere is it as sharply as in the eurozone," they said. A separate report reflected that the composite purchasing managers' index in the region, according to the final assessment, fell to 54.9 points in March from 55.5 points recorded in February. In such conditions, it is difficult for traders to maintain a positive attitude towards the European currency, which is losing against the US dollar for the fourth consecutive day. Optimism on the geopolitical front has faded quite noticeably since last week. A breakthrough below 1.0950 will clear the way for the EUR/USD pair to further decline in the direction of 1.0800, according to OCBC Bank. "Potential new sanctions against Russian coal and oil will be a negative factor for the euro, because it harms Europe as well as Russia," the bank's analysts said.
"The level of 1.0950 is now a key support, in case of its breakdown, the bears' target for subsequent sessions may be the area of 1.0800," they added. On Tuesday, German Foreign Minister Annalena Baerbock said that the EU's complete rejection of hydrocarbons exported by Russia would not only be prepared, but also "massively initiated." This is the issue that will be discussed in Brussels in the coming days. In turn, the Executive Vice-President of the European Commission, Valdis Dombrovskis, said that it does not remove from the agenda the prospects of imposing new sanctions against Russia, including measures against oil and coal. However, consensus among the EU states is needed on this issue. The main currency pair should rise above 1.1000 and use this level as support to attract bulls and start the recovery. Further resistance occurs at 1.1020, 1.1070 and 1.1120. On the other hand, below 1.0950, support is at 1.0910, followed by 1.0870 and 1.0830.
