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02.07.2022 04:25 PM
EUR/USD: Powell is pouring salt on the wound for investors, hinting that it is too early to sell the dollar

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On Friday, global markets were recovering from volatile trading in the previous session.

On Thursday, investors continued to play back statements made by Federal Reserve Chairman Jerome Powell during the European Central Bank forum on Wednesday.

He pointed out that the US central bank will continue to raise rates to curb inflation, even if economic growth slows down.

The day before, the movement of quotes was also influenced by the fact that investors rebalanced their portfolios at the end of the first half of the year, which turned out to be quite gloomy.

The year began with a surge in cases of COVID-19 infection in the world due to the spread of the Omicron strain. This was followed by a military conflict between Russia and Ukraine, high inflation for many decades and an aggressive increase in interest rates by the Fed, which raised fears of a possible recession.

Therefore, it is not surprising that the US stock market has lost $9 trillion since the beginning of the year.

"Stubbornly rising inflation has caused a decisive infusion of the Federal Reserve. The central bank chose to fight inflation, regardless of the economic consequences. Investors are understandably hesitant to buy stocks in the face of a Fed rate hike, they fear a further drop in profits," Citigroup strategists said.

Leaving behind the first six months of the year, many traders doubt that the worst is behind them.

Although the S&P 500 jumped 6.4% last week, it's hard to blame investors for skepticism: the benchmark index has already experienced three such rebounds of at least 6% this year only to then fall below its previous low.

"The bulls have to prove that this is not just a rebound of the bear market," said analysts of the research company All Star Charts, noting that even with the growth of the index last week, more stocks reached 52-week lows than highs.

Even the recent rebound of the broad market index quickly came to naught.

On Thursday, the S&P 500 declined for the fourth consecutive day and dropped 0.88% to 3785.38 points. The index has just demonstrated the worst dynamics in the first half of the year since 1970. Since the beginning of the year, the S&P 500 has fallen by 20.58%.

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Investors fear that the world's largest economy will enter a recession, and are leaving the stock market, reorienting capital towards protective assets, which include the US currency.

The USD index rose to 105.25 points on Thursday, narrowly missing the 20-year high of 105.78 points recorded in mid-June.

The greenback was forced to retreat after consumer spending in the US rose much less than expected in May.

In May, the indicator rose to the lowest 0.2% since the beginning of this year from 0.6% in April. Consumer spending accounts for 70% of US GDP, and these statistics were perceived by the markets as a negative economic signal.

Meanwhile, the PCE Core indicator, which does not take into account the cost of food and energy resources, rose by 0.3% compared to April. The indicator has remained at this level for four consecutive months. In annual terms, the indicator increased by 4.7%, which was the lowest increase in the last six months.

"A less significant rise in core inflation is not a clear and convincing indication that the Fed needs to move to a less aggressive rate hike. But this means that inflation in general is not as bad as one might think," Capital Economics analysts said.

As a result, the greenback was under pressure. This allowed the EUR/USD pair to make a decisive rebound from two-week lows around 1.0380. Not only was it able to recoup the day's losses, but it closed in positive territory on Thursday, rising by about 0.4%.

Nevertheless, the single currency showed a monthly decline of almost 2.5% and a quarterly loss of more than 5%, showing the worst quarterly dynamics since the end of 2016.

On Friday, the dollar regained the positions lost during the previous session and was on its way to its best week in the last four years.

Meanwhile, the euro was heading for a weekly drop of 1.5% against its American counterpart.

"The second half of the year started with risk aversion, equity and commodity markets declined, and the dollar strengthened significantly against most other currencies," Societe Generale strategists noted.

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The greenback ends the week with a rise amid signals of the Fed's readiness to continue tightening monetary policy.

Powell said this week that the US economy is in a good position to cope with the tightening of monetary policy, and the central bank expects that it will continue to grow, but it cannot give guarantees of a "soft landing".

"The fight against inflation is very likely to cause some pain to the economy, but the pain will be greater if we cannot cope with high inflation," Powell said.

The position of the head of the largest central bank clearly indicates that the central bank is much more afraid of accelerating inflation than slowing economic growth. However, this does not make it easier for stock markets.

The shares may fall by another 10% before reaching the "bottom", according to Morgan Stanley analysts.

According to them, the chances that the United States will suffer from negative economic growth for two consecutive quarters doubled after the Fed raised interest rates by 75 basis points on June 15, which makes a downturn in the stock market all the more likely.

"The accelerated tightening of the Fed's policy doubled the likelihood of a recession. The bottom of the bear market may still be at a distance of 5% to 10%," Morgan Stanley reported.

Analysts at JPMorgan Chase said it was now reasonable to consider the risk that the U.S. economy and/or the global economy would slide into recession this year."Growing concern over persistent inflationary shocks, combined with news of a more aggressive Fed policy and a deterioration in sentiment, have significantly changed our views on economic growth in the second half of 2022," they noted.

Investors are now waiting for new data on inflation in the United States, which will be published on July 13.

If the growth of consumer prices in the country continues, the US central bank will have to raise the key rate by 75 bps again at the next meeting. This will contribute to traders' revision of expectations regarding the federal funds rate by the end of the year towards higher values, which will increase pressure on risky assets and support the dollar.

"The greenback is still close to a one-year high, as concerns about a recession cannot affect the basic assumption that inflation is a problem and that the Fed is focused on raising rates to solve it," ING strategists said.

Some experts draw parallels with the 1980s. Then the chairman of the Federal Reserve was Paul Volcker, who managed to reduce inflation from 14.8% in 1980 to 3.6% in 1989. However, the American economy paid for this with a shock, and eventually the United States slipped into recession.

However, the current head of the Fed does not associate himself with Volcker. Powell claims that the central bank is determined to bring inflation under control, but expects that a "hard landing" will be avoided.

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According to the final estimate, in the first quarter, US GDP declined by 1.6% in quarterly terms. In the current quarter, the Fed Bank of Atlanta expects zero dynamics of the national economy.

Meanwhile, the US trade deficit is shrinking, and the volume of inventories in the country increased by 2% in May, which acts as a factor in supporting economic growth. In addition, the presence of excess stocks at the largest retailers pushes them to the decision to lower prices to free up filled warehouses.

Therefore, the Fed may not be hoping for nothing that signs of stabilization of inflationary pressure will appear in the coming months. In this case, the current cycle of tightening monetary policy in the United States will be less aggressive than the market currently estimates.

However, any forecasts for CPI are just an assumption, a recession looks inevitable, and the consequences of any "hard landing" may be greater than we can imagine at the moment.

All this provides confidence to dollar bulls.

The first six months of 2022 were marked by the greenback's dominance in the foreign exchange market, according to ING analysts, who predict that the strengthening of the USD will continue in the third quarter.

"Our opinion remains that the dollar should continue to count on fairly solid ground under its feet in the third quarter due to the Fed's outstripping rate hike and the still difficult global environment for risky assets due to the tightening of the liquidity situation and concerns about a slowdown in the global economy," ING reported.

The greenback quickly shrugged off its recent losses amid growing fears that any slowdown in the US economy would pull the whole world with it.

According to analysts at RBC Capital Markets, the probability that the United States will slide into recession without pulling the rest of the world with it is extremely small. The dollar will look advantageous during the global downturn, they believe.

The US currency left Thursday's pullback behind and returned to the area above 105.00 on Friday.

At the same time, the EUR/USD pair updated two-week lows below 1.0400, losing about 0.7% per day.

The euro has lost ground gained the day before, as the conflict in Ukraine has exacerbated concerns about inflation and economic growth in Europe.

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According to Deutsche Bank, the European economy is facing a new serious shock due to the slowdown in Russian natural gas supplies, which threatens to push inflation even above current record levels and lead to an imminent recession in the strongest country in the region – Germany.

Eurostat reported on Friday that annual inflation in the currency bloc jumped to 8.6% in annual terms in June from 8.1% recorded in May.

Although a strong dollar makes life difficult for American exporters, a side effect of the strengthening of the USD may be a decrease in inflation.

It is not for nothing that this week Powell stated that the strengthening of the greenback is a disinflationary factor.

Meanwhile, the weak euro runs counter to the ECB's goal of ensuring price stability.

According to Bank of America strategists, the ECB itself is at the center of the euro's inability to ensure a sustainable recovery.

The difference in interest rates on both sides of the Atlantic remains a key factor affecting the EUR/USD exchange rate.

The convergence of the positions of the Fed and the ECB is out of the question. The US central bank is going all-in for tightening, while the ECB is still deciding whether it should announce the size and duration of its upcoming bond purchase program.

In addition, investors assess the economic situation in Europe as more precarious than in the United States, aggravated by the energy crisis caused by the military conflict in Ukraine.

Therefore, it is not surprising that the EUR/USD pair remains sold on growth.The 1.0470 mark (the Fibonacci retracement level of 23.6%) acts as the nearest resistance. Bulls are likely to not show interest in the pair as long as this level remains intact.

The initial support seems to have formed in the area of 1.0380-1.0370, followed by the level of 1.0340, which became the lowest point in 2017.

The next obstacles above 1.0470 are 1.0500 (100-day moving average) and 1.0520 (38.2% Fibonacci retracement level).

Viktor Isakov,
Especialista em análise na InstaForex
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