The US currency has cheerfully started a new week. The day before, it strengthened by more than 0.2% against its main competitors, including the euro, extending its winning streak to two consecutive trading sessions.
The hawkish comments of the representatives of the Federal Reserve, combined with a sharp increase in yields in the United States, served as a breath of fresh air for the greenback and provided it with another day of growth.
Meanwhile, discrepancies in the parameters of the monetary policy of the Fed and the European Central Bank, as well as disappointment with the results of the parliamentary elections in Germany explain yesterday's weakness of the euro against the dollar.
Touching local lows around 1.1690 in the European session, the EUR/USD pair circled around the level of 1.1700, eventually closing below this mark.
On Monday, US 10-year bond yields updated three-month highs, rising above 1.50%.
The indicator rose after the Fed hinted that a reduction in monthly asset purchases is just around the corner. Just this week, the yield of "ten-year-olds" added 8 points.
Many analysts expect that the dollar will eventually rise against this background. It may also lead to a weakening of the European currency in the future.
"We are still confident that the USD exchange rate will continue to grow: there are many opportunities for continued growth in the yield of US government bonds, which will lead to an increase in the difference in interest rates relative to low-yielding assets, including the euro," JPMorgan analysts noted.
FOMC hawks have been talking for some time about the need to start curtailing QE in the near future, and their influence in the Committee seems to be growing.
Even New York Fed President John Williams, whose position was one of the most dovish in the FOMC, said that tapering monetary stimulus could soon be justified, while Fed Board member Lael Brainard, another notable dove, also seems to be leaning in this direction. She believes that US employment is only slightly short of the bar needed to reduce asset purchases, but may be reached soon.
"Among the many cross-cutting topics in the foreign exchange market, there is one that seems to be gaining momentum. It lies in the fact that the market is on the verge of revaluation of the Fed's monetary tightening cycle. The normalization of monetary policy in the US in the short term is the key reason why we are optimistic about the dollar, especially from the second quarter of next year," ING analysts said.
In itself, the reduction of QE by the Fed is not a surprise, but an earlier completion of the program will strengthen the dollar, according to TD Securities.
"If we look at the previous taping cycle, then about half of the cyclical rise in USD was observed three months after the start of QE curtailment," the bank's strategists said. They expect the Fed to complete its quantitative easing program by June 2022.
Last week, Fed Chairman Jerome Powell said that the central bank could begin reducing the volume of asset repurchases at the November meeting and complete this process by the middle of next year. On Monday, he noted that inflation in the United States is likely to remain high in the coming months, but then will begin to slow down.
At the same time, Powell acknowledged the risks that inflationary pressures in the country will be stronger than expected or deeper. According to him, the Fed will raise the base interest rate if a significant increase in inflation causes serious concerns.
Meanwhile, ECB President Christine Lagarde once again said on the eve that the current increase in inflationary pressure in the eurozone is likely to be temporary. This suggests that the ECB will not lean in a hawkish direction, regardless of what the data on the consumer price index in the currency bloc for September will show.
Recall that in August, annual inflation in the region reached a record 3% over the past decade. At the same time, the basic indicator (excluding energy and food prices) increased by only 1.6% year-on-year. Thus, the main driver of inflation last month was record high gas and electricity prices in Europe. And the situation only worsened in September: the cost of natural gas in the EU has risen to a record high, exceeding the mark of $1,000 per thousand cubic meters. However, despite high inflation, the ECB is in no hurry to abandon its soft monetary policy, and there is reason to believe that the data on September inflation is unlikely to change anything in the regulator's plans.
The Fed has clearly stated its readiness to begin curtailing the asset repurchase program, which should support demand for the US dollar.
Although the ECB has announced its intention to reduce the amount of QE conducted under the PEPP program, however, it is obvious that even after this step, the central bank will lag behind its US counterpart. This, in turn, is not the best news for the euro.
The focus on Monday also remained on the political situation in Germany, where parliamentary elections were held over the weekend. None of the parties participating in the elections was able to enlist the support of voters necessary for the formation of a government.
Now there are negotiations on the formation of a government coalition, which may take several weeks or even months, analysts at Commonwealth Bank of Australia say.
"The elections in Germany did not bring ready-made answers, except for one - about the impossibility of the most left-wing of the options in which the SPD and the Greens could unite with Die Linke. We can expect a long and difficult process of forming a coalition government. Those who hoped for a strong eurocentric government did not get what they expected. Many predict the formation of a "traffic light" coalition of the "red" SPD, the "Greens" and the liberal FDP. Some consider a "Jamaican" coalition possible, given that the CDU/CSU bloc, although it lost support, still received a little more than the polls predicted," Saxo Bank analysts said.
"Such uncertainty is not very favorable for the euro. Therefore, the single currency is likely to weaken against the dollar, subject to further growth in the yields of treasuries. If the 10-year US government securities return to the high of the 1.75% cycle, and there are no clear prospects for increasing budget spending in Europe, the EUR/USD pair will remain under pressure. If the pair breaks the lower limit of the 1.1664 range, a sell-off to 1.1500 is possible," they believe.
Market participants are in tension on Tuesday, risk aversion dominates the financial scene and the greenback gets the maximum benefit from it, advancing on a broad front.
"The mood of investors is greatly spoiled by recent events: jumps in US government bond yields have reached critical figures, and the key points of the yield curve have reached important thresholds," Saxo Bank strategists said.
"The US Congress is not helping market sentiment, as Republicans in the Senate refused to support the Democrats' initiative to raise the debt ceiling. The threat of a shutdown of the US government seems likely, and the drama around the budget situation may peak this Thursday, when the House of Representatives will vote on the infrastructure bill (without the ability to pay for it without raising the debt ceiling)," they added.
The dollar may increase its current attractiveness if the yield of US government bonds continues to rise and stocks continue to fall, according to analysts at RBC Capital Markets.
Today, key US stock indexes are declining within 2%, while the yield of 10-year treasuries is growing for the fourth consecutive trading session, supporting the protective greenback to the detriment of risky assets and indicating expectations of tightening monetary policy in the United States.
"10-year US Treasury bonds have crossed the psychological border - 1.5%. Among the largest economies in the world, it is difficult to get a yield of 1.5% of the currency, which makes the dollar more attractive," Mizuho analysts noted.
Amid growing demand for the dollar, the EUR/USD pair renewed its September lows around 1.1670.
Commerzbank believes that a breakdown of the August low at 1.1664 will target the pair at 1.1575.
"EUR/USD remains under pressure below 1.1750. The August low at 1.1664 covers 1.1575 (the level close to which the 200-week moving average is) and the previous downward trend at 1.1424. Attempts to intraday growth may fade on the approaches to 1.1750-1.1773, but the key resistance is at the three-month bearish trend at 1.1823," they said.
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