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26.05.2022 11:27 PM
EUR/USD: euro is trying to come out of the shadows, but is doomed for defeat

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The US currency managed to regain its composure on Wednesday after a disastrous beginning to the week.

The USD index moved to growth, pushing off from support around 101.70.

Meanwhile, the EUR/USD pair interrupted a two-day upward trend. The euro's local attack has stalled in the area of $1.0750.

The euro regained some of the points gained after European Central Bank President Christine Lagarde pointed to the termination of negative interest rates in the eurozone in the third quarter.

Since May last year, the single currency has steadily fallen in price against the dollar due to the gap in the rates of monetary policy of the ECB and the Federal Reserve. During this period, the EUR/USD pair lost about 12%.

"The abolition of the negative interest rate policy should provide more support for the euro in the future, given that it has proven effective in helping to maintain the euro's weakness, encouraging record capital outflows to foreign bond markets. It was more normal for EUR/USD to trade above the 1.2000 level in the decade preceding the introduction of negative rates," MUFG Bank specialists noted.

Traders then turned their attention to the Fed, as they were waiting for the release of the minutes from the May FOMC meeting, from which they expected to get more information about the future course of the monetary policy of the central bank.

The reports released ahead of this event on both sides of the Atlantic did little to entertain investors.

Research company GfK reported that the index of consumer confidence in the German economy as of June rose to -26 points from the revised May figure of -26.6 points. The indicator value coincided with analysts' forecasts.

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"Although the consumer climate has improved slightly, consumer sentiment is still at an all-time low. Despite the further easing of restrictions related to the COVID-19 pandemic, the military conflict in Ukraine and especially high inflation strongly affect consumer sentiment," GfK representatives said.

At the same time, the volume of orders for durable goods in the United States increased by only 0.4% in April on a monthly basis, which turned out to be worse than the expected growth of 0.6%. At the same time, the March value of the indicator was revised downwards – from 1.1% to 0.6%.

In the absence of high-level macroeconomic data, the dollar managed to find demand as a safe haven asset. The USD index reached a local high around 102.45 on Wednesday.

Meanwhile, the EUR/USD pair remained under bearish pressure for most of yesterday.

The strengthening of the US currency against its main competitors was largely facilitated by fears that an aggressive tightening of the policy of the US central bank could provoke a recession in the United States, which in turn would have a negative impact on the entire global economy.

In addition, investors are still concerned about the consequences of the situation around Russia and Ukraine, as well as quarantine restrictions in China due to the coronavirus, as recalled by FOMC members.

"High inflation is our most pressing problem. That is why we are taking decisive actions that will bring inflation back down," said Lael Brainard, Vice Chairman of the Federal Reserve, on Wednesday.

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All participants of the Fed meeting held on May 3-4 supported raising the rate by half a percent to combat inflation, which, in their opinion, has become a key threat to the economy and may grow without the actions of the central bank, the minutes of the meeting showed.

At the same time, some officials wondered if inflation had reached its peak. A number of participants in the May meeting suggested that the increase in price pressure may stop. However, they acknowledged that it was too early to state this with certainty. According to them, the situation in Ukraine and lockdowns in China may worsen inflation in the short term.

The minutes also reflected that politicians unanimously believe that the US economy is very strong, and this will allow them to curb inflation without triggering a recession.

"Unity of opinion is good. There is no uncertainty about what needs to be done in the near future. By the time Fed officials get to September, they will have enough economic data to make their move from there, so they continue to maintain optionality," Baird strategists said.

"There are signs that inflation is doing the job for the Fed. The economy is already cooling, and financial conditions have tightened over the past month due to the strengthening of the dollar and the weakness of the stock market," they added.

Since the minutes did not bring hawkish surprises, at least there was no mention of a more significant rate hike, the key Wall Street indexes closed yesterday with an increase, adding about 1% on average.

Meanwhile, attempts to test the 102.50 area with the US currency attracted those willing to partially take profits, which pushed the greenback back to 102.00.

However, the dollar retained most of its daily gains, gaining almost 0.3%, while the euro fell more than 0.5% to 1.0680 on Wednesday.

The USD index was trading without a clear direction on Thursday, fluctuating around 102.00, as the markets have not learned anything new from the minutes of the May Fed meeting and nothing indicates further strengthening of the already hawkish position of the central bank.

The central bank only emphasized its intention to cool inflation and indicated that it considers it appropriate to raise interest rates by 50 basis points at the next meetings. Investors have been putting such a scenario into quotes for quite a long time.

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"To some extent, the markets were confident that the Fed was not going to tighten policy more aggressively than expected. But market sentiment remains tight. There is still a lot of uncertainty about what will happen if inflation remains high," SYZ Private Banking said.

BlackRock strategists believe that July will be a turning point for the Fed.

"With two more half-percentage increases, the course of policy after July will depend on the path of inflation and progress in correcting labor market imbalances. If these factors improve, then the Fed gets some breathing room to move towards smaller rate hikes. Otherwise, the central bank will be forced to put more pressure on the economy," they said.

According to Commonwealth Bank of Australia analysts, the dollar's safe-haven appeal should support it in the future."A firm commitment to fighting inflation and a willingness to pursue a tight monetary policy suggest that the FOMC may not provide a soft landing for the US economy, which will support the greenback," they said.

Over the past two weeks, the US currency has fallen in price by 3% after reaching its two-decade high of 105.00 points.

"It is too early to talk about the formation of a long-term high for the USD, although a more weakened macroeconomic background for the dollar is now forming. China is starting to restart its economy again after lockdowns, the ECB is becoming more hawkish, and tightening financial conditions in the US are beginning to weigh on the country's economy," Westpac analysts said.

"The USD index may hover in the 101.00-105.00 range for some time, but the long-term peak has not yet been passed," they added.

On Thursday, the EUR/USD pair regained some of the positions it lost on Wednesday and is now trying to settle above 1.0700.

The prospect of an ECB rate hike in the third quarter is a beacon of light at the end of the tunnel for the single currency.

Money markets are quoting at least four hikes of 0.25% in eurozone rates by the end of this year.

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Politicians in Brussels are now debating whether larger hikes are needed to keep the public's faith in the central bank's commitment to lower inflation. Lagarde said on Tuesday that only a gradual increase in rates is needed until inflationary expectations ease.

Other members of the ECB's Governing Council, including Austrian and Dutch central bankers Robert Holzmann and Klaas Knot, pushed for a 50 basis point rate hike as early as July. Meanwhile, the head of the Finnish central bank, Olli Rehn, sided with Lagarde on Wednesday, although he noted that inflationary risks had definitely increased.

ECB Chief Economist Philip Lane, in turn, said that the central bank should start raising its interest rates in the third quarter, but the path after September is overshadowed by the conflict in Ukraine and its impact on inflation.

"Given the uncertainty over the conflict in Ukraine, and how quickly inflation will fall, the ECB should remain optional, flexible and gradual," he said.

At the same time, it is important to understand that even before July, when the first ECB rate hike is due, a lot can happen.

"A much more hawkish ECB is hard to imagine at the moment. There are also economic uncertainties and risks in the euro area that could force the central bank to act more cautiously, especially in the event of an energy crisis," Commerzbank strategists said.

The 1.0700 zone, intraday low at 1.0664 and the 1.0600 mid area are acting as support for the EUR/USD pair. On the other hand, above 1.0720, resistance lies at 1.0750, reinforced by the 50-day MA at 1.0755, Scotiabank economists say.

Given the current price action, a continuation of the rebound in the short term looks likely. EUR/USD may well reach 1.0800.

However, attempts to extend the rally, accompanied by a breakdown of the level of 1.1000, where the 100-day moving average is currently located, can attract investors who prefer selling on growth.

Meanwhile, the dollar's retreat from multi-year highs is most likely a temporary correction aimed at neutralizing its overbought conditions.

The greenback will continue to be supported by its status as a safe haven asset, the demand for which will only grow against the background of the expected recession in America, the conflict in Eastern Europe, as well as increased tensions between China and Taiwan.

Assuming that in the course of normalizing its monetary policy, the Fed will face fewer difficulties compared to the ECB, then USD pullbacks to 101.00 should be considered as an opportunity to open long positions on the US currency.

Viktor Isakov,
Especialista em análise na InstaForex
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