On Monday, the euro and pound continued to build on last week's positive momentum, while the greenback retreated even further from the 20-year highs recorded earlier at 114.78.
The greenback tried in vain to find demand amid increased risk appetite.
The key Wall Street indices ended the first trading session in October with strong growth.
In particular, the S&P 500 rose 2.59% to 3678.43 points. At the same time, 11 sectors of the index closed in positive territory.
Investors drew attention to the statistical data for the United States, which indicated a decline in business activity in the country's manufacturing sector in September to the lowest level since May 2020.
The Institute for Supply Management (ISM) reported that the US manufacturing PMI slipped to 50.9 last month from 52.8 in August.
The bad news is taken as good news by traders as it speaks in favor of the FOMC having to stop the rate hike cycle sooner than expected.
The derivatives market puts into quotes the likelihood that the Federal Reserve will pause in tightening policy after the December meeting.
The price component of the ISM manufacturing PMI fell from 52.2 to 51.7 points, while the employment component fell from 54.2 to 48.7 points. The data hints that the Fed's aggressive tightening is already being felt.
Many market participants doubt the need to raise rates due to fears that the actions of the US central bank will disrupt the financial markets and send the national economy into recession. Others believe that the United States has already experienced its worst surge in inflation and that price pressures will ease on their own.
New York Fed President John Williams said on Monday that despite emerging signs of slowing inflation, underlying price pressures remain too high. This means the US central bank must move forward to bring inflation under control, he said.
"The tightening of monetary policy has begun to cool demand and reduce inflationary pressures, but our work is not yet complete," - said Williams.
Lower economic growth and higher unemployment are likely to be side effects of the Fed's mission to fight inflation, he said. Economic activity is likely to be close to zero this year, with little growth next year, and the unemployment rate, currently at 3.7%, could rise to 4.5% by the end of 2023, Williams said.
The Fed's leaders continue to claim that they do not want to provoke a recession. They point out that the American economy is too strong for a serious and protracted recession to occur in it.
The UNCTAD believes that the very idea that leading central banks will be able to reduce inflation by further raising rates and at the same time avoid a recession is an "ill-advised gamble."
The trade group has cut its forecast for global GDP growth from 2.6% to 2.5% this year and expects it to slow even more in 2023, when the rise will be only 2.2%.
It sees the need for countries with developed economies to change the course of monetary policy, since excessive tightening of it is fraught with the onset of a global recession.
Traders are beginning to wonder whether the slowdown observed in the US economy and the whole world will force the Fed to adjust the trajectory of rate hikes in a smaller direction.
This caused a sharp rally in US Treasury bonds last week, which led to a decrease in the yield of treasuries along the entire curve, brought relief to risky assets and put pressure on the protective dollar.
"The USD pullback coincided with a sharp correction in yields in the United States. These two steps have brought much-needed relief to risky assets," MUFG analysts said.
"The movement of the dollar and yields partly reflect the confidence of market participants that the US central bank is approaching the end of the interest rate hike cycle. Market expectations regarding the peak interest rate on federal funds for next year have decreased from about 4.75% to 4.39%," they added.
The main Wall Street indexes registered impressive growth on Monday, while the greenback closed at the lowest level in more than a week at 111.60 points.
According to the results of Monday's trading, the greenback fell by 0.2% against the euro and by 1.4% against the pound.
Sterling welcomed the decision of the UK government to abandon the plan to abolish the 45% income tax rate for the wealthiest citizens.
The GBP/USD pair rose ahead of the fifth consecutive session, adding about 165 points. It has risen by more than 9% from the record low recorded near 1.0327 last Monday.
"The recovery of sterling is striking. This makes some sense, since yields in the UK will be high for some time, which prevents short positions on GBP/USD. But, given that Great Britain already has a very large current account deficit, we doubt that the pound has much more growth potential," Westpac strategists said.
Sterling has returned to the levels at which it was trading before the announcement of the so-called "mini-budget" by the Liz Truss government, however, the current rally of the pound does not look stable, ING analysts believe.
"We believe that the pound continues to face very significant downside risks, as a large budget deficit, low market confidence in the new government and gloomy prospects for Europe ahead of winter indicate the instability of the 1.10+ area for the GBP/USD bulls," they said.
The British energy regulator Ofgem said that the country faces a gas shortage amid the energy crisis.
"It is possible that the UK will declare an emergency situation in the field of gas supplies, under which supplies to some gas power plants may stop, because of which they will not be able to generate electricity," The Times newspaper reports.
In this regard, Ofgem points out that a number of gas-fired power plants may be bankrupt.
"The regulator's statement is likely to increase the fear of planned power outages, because the United Kingdom relies on gas-fired power plants to receive the largest share of electricity supplies," the newspaper reports.
Ofgem warns that the coming winter will be more difficult than the previous one.
The recovery of the single currency also looks quite fragile, given the still very difficult prospects for the eurozone and increased uncertainty about the energy crisis in the cold months, ING analysts say.
"The EUR/USD recovery looks quite fragile. This means that any slight recovery of the dollar could trigger a broader correction in the pair. We still see a high risk of a return to 0.9500 in the coming weeks," they said.
The euro showed more modest gains than the pound on Monday.
Following the results of Monday's trading, the EUR/USD pair rose by about 25 points from the previous closing level of 0.9799.
In the European trading hours, the pair was under light selling pressure after S&P Global reported that the index of business activity in the manufacturing sector of the eurozone, according to the final estimate, fell to 48.4 points in September from 49.6 points in August. The indicator has become the lowest in more than two years.
The euro was able to shrug off its daily losses during the US session. This was facilitated by data published by ISM. Details of the report on business activity in the US industrial sector last month showed that employment in the sector declined, and pressure on production prices continued to weaken, which allowed investors to lower rates on the hawkish position of the Fed.
Global markets remain positive on Tuesday, which undermines demand for a protective US currency.
The main US stock indexes were growing noticeably on Tuesday. In particular, the S&P is adding about 3%.
The surge of optimism in world markets is caused by the easing of concerns about the aggressive policy of leading central banks. There were hopes that the risks to the economy could force central banks to stick to a more "soft" course.
Amid increased risk appetite, the greenback slides, losing about 1.2% and testing the strength of support in the 110 area.
In case of strengthening the bearish momentum, 109.30 (weekly low of September 20) and 108.60 (55-day moving average) may come into play.
However, the dollar's short-term prospects should remain positive as long as it trades above the seven-month support line, which runs around 107.20.
In the longer term, USD is expected to remain constructive as long as it remains above the 200-day moving average at 102.60.
Before turning around, the dollar will still grow, according to MUFG Bank.
The strengthening of the greenback will continue during the fourth quarter, and only when there is a clear feeling that the Fed is pausing, it is worth waiting for a reversal of the US currency, the bank's strategists predict. The beginning of this will be the first quarter of 2023, they believe.
MUFG Bank expects the EUR/USD pair to fall to 0.9000, and then begin to recover next year.
"We believe that in the near term, the risks for EUR/USD are strongly shifted downward, and we expect a period of further strengthening of the US dollar as conditions in the financial markets deteriorate. The key to any turn in the strengthening of the USD should be a pause in the Fed's tightening cycle. We suspect that the US central bank will take a pause after the rate hike in December, which should trigger the recovery of EUR/USD from levels closer to 0.9000," the bank's analysts said.
The EUR/USD pair maintained a bullish momentum on Tuesday and came close to parity.
Societe Generale analysts believe that the pair has limited growth potential.
"A steady rebound in oil prices after the OPEC+ meeting on Wednesday and strong US employment data on Friday should limit the growth potential for EUR/USD before the release of the US consumer price index on October 13," they noted.
"The seasonal bearish mood in October may become another obstacle. The pair declined in October in seven of the last ten years and by an average of 0.6%," Societe Generale added.
"European assets still have a long way to go to regain the market's favor, given the energy crisis and geopolitical events. We still believe that any decline in the dollar caused by the recovery of European sentiment is likely to be short-lived," ING said.
So far, the euro and the pound are trying to make the most of the weakening of the greenback position.
Sterling extends its rebound from a historic low and gains momentum for the sixth consecutive day on Tuesday.
Recently, the GBP/USD pair marked a record low near 1.0350, and now a rebound is forming. However, the downward trend will continue as long as the pound remains below $1.1760-1.1840, Societe Generale believes.
"After the recent sharp fluctuations up/down, a consolidation phase is not excluded. The lower limit of the range from 2016 at the level of 1.1760-1.1840 is expected to become an important resistance zone in the near future. As long as the pair stays below this mark, the downward trend may continue," the bank's analysts said.
"Failure to sustain recent high low at 1.0550 could lead to another round of downtrend towards 1.0350 and next targets in the 1.0140-1.0000 area," they added.
