EUR/USD: dollar is drifting down, but will still try to take the euro on fright

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 The greenback strengthened by almost 0.2% against its European counterpart on Friday. However, this growth was not enough to compensate for the losses that pushed the dollar away from a five-year high against the single currency. Following the results of the last five days, USD fell by about 1.3% against EUR, which was the worst weekly indicator for the US currency against the euro since the beginning of February. The EUR/USD pair has declined by 15% over the past 12 months. Two-thirds of these losses occurred in the current year. The US currency was supported by investors' flight into safe haven assets due to fears of the consequences of a sharp rise in inflation, the hawkish policy of the Federal Reserve and the Russian-Ukrainian conflict. Meanwhile, the euro has come as close as possible to parity with the dollar, having recently reached a five-year low of $1,0350. This partly reflects the relative weakness of the eurozone economy, which has suffered from a jump in energy prices, and is also due to the European Central Bank's excessively soft monetary policy, in sharp contrast to the aggressive attitude of the Fed. The USD rally has stalled around two-decade highs just above 105.00. While investors are wondering whether the greenback has already reached its peak, the euro is gathering strength after excessive oversold, accumulated over a year of EUR/USD decline with short stops. Having touched the lowest levels since January 2017 on May 13, the main currency pair headed for recovery. Over the past week, it has gained almost 150 points and finished around 1.0560 on Friday, having managed to rebound from a local low near 1.0535. Some investment in the single currency was brought about by the fact that European politicians could not agree on the sixth package of anti-Russian sanctions, including a phased embargo on Russian oil.


According to experts, oil and gas restrictions against Russia will bring the EU not only an increase in prices, problems with employment and GDP growth, but also effects that go beyond the macroeconomic paradigm. The euro also benefited from German manufacturing inflation data. The report published at the end of the last five days showed that in April the producer price index in the country increased by a record 33.5% in annual terms. It is believed that in Germany, more than in any other European country, the fear of inflation is strong, because it corrodes the savings of Germans. Obviously, the Bundesbank cannot act alone by tightening policy, but it is able to create a hawkish coalition in the ECB. On Friday, the head of the Bundesbank, Joachim Nagel, said that negative interest rates are a thing of the past. In response to a question about whether the ECB could raise the rate by 50 bps in July, Nagel said that it was important to raise rates and discuss the rest in the Governing Council. The EUR/USD pair was able to gain momentum at the beginning of the new week, as the safe haven dollar remained in the shadows due to an increase in risk appetite. This was facilitated by the news that Shanghai, the commercial center of China, is going to lift citywide restrictions and return to normal life from June 1. In addition, last week Beijing authorized an unexpectedly large rate cut, which was perceived as a signal that the Chinese authorities were going to support the world's second largest economy. Market participants also welcomed the statements of US President Joe Biden. He said that Washington is considering lowering tariffs for China, and added that a recession in the United States is not inevitable.


The euro received additional support from the unexpectedly encouraging IFO report on Germany. As follows from the report of the German research institute, the business climate index in the country in May increased to 93 points from the April level of 91.8 points. Analysts predicted a decline in the indicator to 91.4 points. The index of economic expectations also rose to 86.9 points from the revised April figure of 86.8 points.All this led to the fact that the EUR/USD pair rose above 1.0670, surpassing the Fibo correction level by 38.2% relative to the decline from 1.1184 to 1.0348. A breakthrough above 1.0710 will create conditions for testing the April 21 high in the area of 1.0935, analysts at Brown Brothers Harriman say."On Monday, ECB President Christine Lagarde said that the central bank is likely to exit the negative interest rate zone by the end of the third quarter. This supports current market expectations, according to which the tightening will begin on July 21 with a rate increase of 25 bps, and then another 25 bps on September 8, which will return the deposit rate to zero. The subsequent increases on October 27 and December 15 are also fully embedded in the prices, and as a result, the deposit rate should reach 0.5% by the end of the year," the analysts noted. "Market expectations regarding the ECB have not changed after Lagarde's remarks, and yet the euro has risen. At some point, weak ECB forecasts should put pressure on the euro, but at the moment the foreign exchange market is happy to pull down the dollar," they added.


Sharply selling the US currency, which began last week, continued on Monday. The USD index is trading with a decrease of almost 1% on Monday, testing the strength of support at 102.00. "We consider the weakening of the US dollar as just a temporary correction. If we look at the main reasons why the greenback has strengthened so much in recent months, we do not think that the fundamental picture has changed significantly over the past week," said strategists at MUFG Bank. "But in the very short term, there is a risk that this correction may continue further," they added, pointing to the build–up of long positions on the dollar in recent weeks, which makes the US currency vulnerable. ING economists believe that USD will find support around 101.00-101.50. "We believe that a long squeeze on the US currency may become a factor of additional pressure on it in the coming days, but this week we note a higher probability that the dollar will begin to stabilize or show signs of recovery, given the still favorable prospects for monetary policy and the US economy. The area of 101.00-101.50 may represent the bottom of the USD correction," they said. There are no important releases scheduled for publication in the United States on Monday, so the players' attitude towards risk has a significant impact on the greenback's dynamics. New data on business activity in the United States will be released on Tuesday. Signs of a cooling economy will spur concerns about inflation, which pushes the Fed to aggressively tighten policy at a time when the economy is threatened with recession. This will contribute to the resumption of demand for a protective dollar. For fans of the US currency, the minutes from the Federal Reserve's last meeting, which will be released on Wednesday, are also of interest. Dollar bulls will count on the hawkish tone of the central bank, as it raised the rate by 0.5% this month. However, in the current conditions, a USD growth in response to the minutes will only be possible if the central bank hints at a more aggressive increase in the cost of borrowing, since hopes for a 75 bps rate hike in June are gradually melting away.


At the same time, it is also not worth waiting for a significant weakening of the US currency, since the tightening of the Fed's monetary policy promises to go faster than its main competitors, including the ECB. The key level to watch for USD is 101.80, since its breakthrough will result in testing the April 21 low around 99.82, analysts at Brown Brothers Harriman believe. The pendulum of market sentiment is likely to swing back in favor of the dollar, they say. "We still consider the current weakening of the greenback as a correction within the framework of a long-term rally," Brown Brothers Harriman reported. At the beginning of the new week, the US currency is experiencing difficulties attracting demand as a safe haven asset, as investors try to shrug off the disturbing thoughts that have been bothering them lately. On Monday, the key Wall Street indexes are growing as part of the correction, adding about 2% on average, after falling by 3% last week.The greenback may resume growth if geopolitical tensions, high inflation around the world and expectations of an aggressive Fed rate hike return to traders' radars. If a temporary pullback of the US currency is followed by a new wave of growth, this momentum may remain in force up to 120, returning the dollar to levels not seen since January 2002. ING economists expect the EUR/USD pair to slow down as it approaches the 1.0700 mark, as the greenback stabilizes. "We believe that the EUR/USD growth potential is shrinking, and as the dollar potentially stabilizes or recovers, the pair's rally may begin to tire as it approaches the 1.0700 mark. Beyond a very short-term perspective, a return to 1.0500 seems very likely," they noted.



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