The greenback is still trading near the highest levels in the last two decades, despite talk that the American economy may have already plunged into recession.
The Atlanta Federal Reserve's GDPNow tool indicates a 2.1% contraction of the US economy in the second quarter after its 1.6% decline in the first quarter.
It should be noted that this indicator is often quite at odds with real data. So it is not yet a fact that US GDP growth in the second quarter will be negative.
Now the consensus forecast of experts assumes the rise of the American economy in April-June by 2.5% in quarterly terms.
However, if the forecast of the Federal Reserve Bank of Atlanta is confirmed by official statistics, which will be released at the end of July, it will turn out that the recession in the United States began in the first half of this year, whereas many economists expected it not earlier than next year.
Fears about the onset of a recession in the US are not necessarily negative for the dollar. It depends on whether the risk of recession is also considered for the rest of the world, at least for large economies, analysts at Commerzbank say.
"Currently, the topic of the recession affects not only America. There are also similar concerns in the UK, in the eurozone or in China. This weakens sentiment in financial markets, and usually the US dollar is able to benefit from such situations," they said.
In recent months, USD has been supported by concerns about the global recession, forcing investors to transfer funds to safe havens.
The continued acceleration of inflation is forcing leading central banks to tighten monetary policy, which worsens the prospects for the global economy.
Last month alone, central banks controlling seven of the ten most actively traded currencies raised rates by 350 basis points – almost half of the total of 775 basis points imposed by policy makers across the G10 group this year.
"Historically, the dollar has been showing high performance in the presence of three factors: global inflation of more than 5% year-on-year, slowing global growth and tightening the policy of central banks. The last time this happened was in the 1980s. Something similar is being observed now," Lombard Odier strategists said.
Many large countries will enter recession over the next 12 months amid tightening government policies and rising cost of living, which will push the global economy to a synchronous slowdown, Nomura analysts believe.
At the same time, experts note that the depth of the recession will vary in different countries.
Nomura predicts a shallow but prolonged recession in the United States for five quarters, starting at the end of 2022. In Europe, the recession could be much deeper if Russia completely blocks gas supplies to the region, according to the bank's strategists.
Risky assets, led by US stocks and the euro, have received a significant blow this year amid fears that leading central banks seeking to gain control over inflation are likely to make mistakes due to excessive tightening of monetary policy.
The S&P 500 index entered a bear market, falling by more than 20% from the peak levels of the beginning of the year.
During the same time, the euro has fallen by about 9% against the dollar.
"All year it has been a tug of war between inflation and a slowdown in growth, as the Fed tried to avoid an open panic by balancing tightening financial conditions with solving inflation problems. Most likely, we are already in a recession, and now the only question is how tough it will be. It seems that we are unlikely to see a "soft landing"," the specialists of Simplify ETF said.
Meanwhile, Morgan Stanley strategists expect only a moderate economic downturn in the United States. They believe that investors should not wait for a repeat of 2008, when the S&P 500 collapsed by more than 20% in one week.
According to experts, recessions caused by inflation affect stock profits much less strongly than recessions caused by the credit crisis.
"This recession will be caused by inflation, not by lending. This means that the profit from the peak to the low is likely to decrease by less than 15%, as nominal prices mitigate the fall in real volume," Morgan Stanley said.
The positive thing for stocks is also that the recession may prompt the Fed leadership to slow down the aggressive interest rate hike.
The market estimates the probability of another increase in the federal funds rate by 75 basis points this month at about 85% and expects the rate to be 3.25-3.5% by the end of the year.
"At the same time, the market is moving to expectations of an increasingly aggressive Fed rate cut in 2023 and 2024, which is consistent with the growing likelihood of a recession," National Australia Bank analysts said.
"At the moment, the quotes include a reduction in the cost of borrowing in the United States next year by about 60 bps," they added.
At some point, there will be a recession in America. Given that the Fed will be forced to cut rates in this regard, the dollar is unlikely to fully benefit from an increase in interest rates, according to economists at Commerzbank.
"Interest rates will continue to rise in the United States in the short term because high inflation is a more pressing issue at the moment. The prospect of a recession in America and the resulting prospects for a Fed rate cut next year are the reason why we believe that the greenback will not be able to fully benefit from an increase in interest rates," they noted.
Wells Fargo analysts remain optimistic about the US dollar in the short and medium term.
They forecast USD strengthening against most major currencies until the beginning of 2023.
"Given that the US economy is likely to fall into recession, and the Federal Reserve will begin to lower interest rates, we believe that the dollar will peak in mid-2023 and will gradually weaken in the second half of next year," Wells Fargo said.
Meanwhile, in the eurozone, the current policy tightening cycle may be even shorter than in the United States.
At the same time, signs of a slowdown in economic growth in the eurozone may force the ECB to remain cautious about normalizing policy.
Last week, European Central Bank President Christine Lagarde stressed the importance of optionality regarding the timing and size of any interest rate changes after the July 0.25% increase.
Member of the ECB Governing Council Fabio Pannetta, in turn, said that further adjustments to the monetary policy of the central bank will depend on changes in the prospects for inflation and the economy.
"Given the prevailing uncertainty, the normalization of monetary policy should remain gradual. At this stage, inflation expectations are about 2%, and wage growth remains moderate. We are closely following these developments. And we need to see how the economy reacts to the tightening of financing conditions and the deterioration of global and domestic economic prospects," he said.
The ECB is preparing to raise interest rates for the first time in a decade later this month.
However, the prospects of tightening monetary policy in the EU may not support the euro on the long-term horizon, strategists at National Australia Bank say.
"Europe is still stuck in the middle between the Russian-Ukrainian crisis and the weakening of the global economy. Given the difficult situation in Europe, it is difficult to expect a prolonged rally of the euro, which can preserve the strength of the dollar for a longer period," they said.
Although the ECB is likely to return the deposit rate to positive territory, it will remain a relatively lagging central bank on the path to normalizing policy. This leaves the picture for the euro weak, according to analysts at Lombard Odier. They maintain their 12-month target for EUR/USD at 1.0200.
Experts note that the currently observed degree of strengthening of the US dollar is unprecedented over the past twenty years, and a simple argument about the return of the USD to the average value suggests that at some point the greenback will peak and turn around.
"However, for now it makes sense to hold long positions on the US currency, given the current global macroeconomic situation with weak growth and increased inflation," Lombard Odier said.
The EUR/USD pair ended Monday's trading with a symbolic decline (by 0.06%), failing to develop Friday's rebound. The greenback also closed almost unchanged, just below the 105.00 mark.
Tracking cautious market sentiment, S&P 500 futures lost 0.4%. US stock exchanges were closed yesterday in connection with the celebration of Independence Day.
For the same reason, the US economic calendar was empty the day before.
The releases published on Monday on the other side of the Atlantic did not please euro fans at all.
According to the Sentix survey, in July, the investor confidence index in the eurozone fell to -26.4 points from -15.8 points recorded in June.
The current situation index for the reporting period reached a 16-month low of -16.5 points against -7.3 points in the previous month.
According to Sentix representatives, the current decline in assessments of the situation justifies expectations of the inevitability of a recession, and the main task is to determine the depth of such a recession.
Meanwhile, Germany reported its first monthly trade deficit since 1991 after an unexpected drop in exports in May.
The negative balance of €1 billion suggests that the export-oriented German economy is fully feeling the impact of the conflict in Ukraine and the COVID-19 quarantine restrictions imposed by China and the associated damage to international supply chains.
Against this background, the EUR/USD pair lost its upward momentum and finished in the area of 1.0422, although earlier in the course of trading it reached local highs in the area of 1.0460.
The euro faced strong bearish pressure on Tuesday, while the dollar strengthened on a broad front.
The USD index reached its highest level in almost two decades, rising above 106.50 points on Tuesday, amid general pessimism in world markets.
The main Wall Street indexes are noticeably declining, having returned from a long weekend.
"We believe that global markets will reach their bottom either this year or in the first half of next year. In the last six months, the strongest change in consumer sentiment has been observed, and the prospects for global companies in the third quarter remain poor," Saxo Bank analysts said.
Reflecting investors' flight from risk, the EUR/USD pair broke through key support levels around 1.0350-1.0400 and plunged to the lowest values since December 2002.
The euro fell sharply on Tuesday, as the latest jump in gas prices in Europe increased fears of a recession.
Strategists at MUFG Bank note that the risks of the eurozone sliding into recession seem to be growing after another jump in natural gas prices in the eurozone.
"It will continue to be very difficult for the euro to grow in any meaningful way, as the energy situation in Europe is deteriorating and the risks to economic growth in the region are noticeably increasing," they said.
Norwegian Equinor suspended production at a number of fields due to strikes, which pushed up gas prices. And from July 11 to July 21, Nord Stream will stop for scheduled maintenance work.
Against this background, gas futures in Europe are growing by 6%, rising above $1,800 per thousand cubic meters.
A separate downside risk for the eurozone economy is the situation with COVID-19.
In particular, as of July 4, the number of coronavirus cases in Germany amounted to over 147,000.
The threat of a new large-scale wave of the pandemic may force the European authorities to return Covid restrictions, if not in the summer, then in the fall. This will hit economic growth in the eurozone.
Pressure on the euro is also exerted by a decrease in expectations regarding the tightening of the ECB's monetary policy due to growing concerns about a recession in the region.
Judging by the futures quotes for the ECB base rate, the market expects it to increase by less than 140 basis points this year, whereas three weeks earlier it was predicted to rise by more than 190 bps.
The EUR/USD pair sank by almost 1.6% on Tuesday before it managed to find a local "bottom" in the area of 1.0235-1.0250.
Oversold conditions suggest that a technical correction may occur before the next stage of decline.
In this case, the 1.0350 level will be the initial obstacle on the way to 1.0380 and 1.0400.
On the other hand, the nearest support is at 1.0210, and further – at 1.0170. A breakdown of the last level will mean that parity testing is just around the corner.