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06.07.2022 11:48 PM
EUR/USD: The ECB is late to the party, leaving the euro alone with its fears in an embrace, and the dollar is wondering how soon the Fed can change the plate

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After the strongest collapse of the EUR/USD pair since March 2020, it seems that only the most avid fans of the euro remained on the foreign exchange market.

Can they count on something, or a fall to parity and even lower is inevitable.

The single currency was under selling pressure yesterday after the bears were able to push it below $1.0360-1.0350.

When this area, which the bulls managed to defend three times in the last month and a half, fell, the euro collapsed.

According to the results of yesterday's trading, the EUR/ USD pair plunged by about 1.5%.

It is noteworthy that on Tuesday morning nothing foreshadowed a thunderstorm.

US stock index futures rose slightly, indicating a slightly optimistic market sentiment.

Investors played back the news that the US administration plans to roll back some tariffs on Chinese imports in an attempt to ease inflationary pressures.

A certain share of the positive was made by strong statistical data on China, which showed that the PMI index in the country's services sector from Caixin rose sharply to 54.5 points in June from 41.4 points in May, surpassing the forecast of 47.3 points by a wide margin.

Against this background, the EUR/USD pair fluctuated in a relatively narrow range, changing within 20 points and continuing the sideways dynamics of Monday.

However, a general flight from risks began already at the beginning of the European session, which helped the protective dollar gain momentum.

Tracking the deterioration of market sentiment, US stock index futures fell sharply, losing about 2% on average.

At the same time, the greenback has significantly strengthened against its main competitors. The USD index has updated the highs since December 2002, exceeding the mark of 106.50.

Although other currencies also suffered, the main blow fell on the euro, as the topic of the divergence of the European Central Bank and the Federal Reserve rates began to play with new colors, and fears increased that the eurozone would slide into recession faster than the United States.

Touching the local high around 1.0446, the EUR/USD pair sank by more than 200 points.

The weak indicators of business activity in the eurozone served as a starting point for short positions on the single currency.

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According to the final assessment, the composite purchasing managers' index of the currency bloc fell to 52 points in June from 54.8 points recorded in May.

Although the indicator value was higher than the preliminary estimate of 51.9 points, it fell to a 16-month low, which means an increase of only about 0.2% for the quarter. Weak indicators of new orders and business confidence suggest that this quarter will be even worse.

Nomura strategists believe that Europe will slide into recession faster than America. They expect the eurozone economy to fall into recession by the third quarter with an overall GDP decline of 1.7%.

Signs of an impending recession have led investors to question the ECB's determination to sharply raise the rate.

ECB benchmark rate futures data show that traders do not see the central bank's rate increase by more than 1.4% in 2022. Back in mid-June, the estimate was much higher - at the level of 1.9%.

At the same time, the ECB is likely to continue to lag behind its American counterpart in the cycle of tightening monetary policy.

Even at the current stage, this contrast is no less significant. The ECB's key rate is currently at 0% against the Fed's discount rate of 1.75%.

Rising gas prices in Europe and a reduction in the supply of "blue fuel" from Russia exacerbate concerns about economic growth in the region.

Goldman Sachs has raised its forecasts for natural gas prices, saying that a full restoration of Russian gas supplies via Nord Stream 1 is no longer the most likely scenario.

"Europe's energy dependence on Russia is declining, but not fast enough to avoid a recession in the event of the closure of the Nord Stream-1 pipeline. If this happens, the EUR/USD pair is likely to lose another 10% or so," Societe Generale analysts noted.

The euro is under pressure not only from the threat of gas shortages, Berenberg analysts say.

"Already high energy costs are a burden. Energy costs in Europe are many times higher than in the United States," they said.

Electricity prices in Germany have reached record highs. Recently, the Bundesbank estimated that the national economy could decline by 5% in the case of rationing of gas consumption.

"It feels like we are not far away from such a scenario now. The EUR/USD pair looks like it will strive for parity this month," ING strategists said.

Nomura analysts lowered their target for the main currency pair to 0.95. They believe that parity may be violated as early as August.

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The euro's decline is another headache for the ECB. The central bank has to make difficult decisions, reducing economic incentives and gradually tightening monetary policy, as inflationary pressures in the EU countries continue to increase.

Although the ECB understands that fighting inflation by raising interest rates will be expensive, they have no other choice.

The central bank is already being criticized for the lost time when inflation could have been brought under control at the initial stage of its growth.

It is expected that after a 25 basis point rate hike at the July meeting, the ECB may raise the rate by 50 basis points in September or October, followed by another 25 basis point hike in December.

So far, the interest rate differential on both sides of the Atlantic is playing in favor of strengthening the dollar against the single currency.

And in the current situation, euro bulls have nothing to cling to yet, except for expectations of weak data on the US labor market, which will be released on Friday.

Economists predict that 270,000 jobs were created in the United States in June, which is less than 390,000 in the previous month.

A weaker-than-expected report on US employment may increase fears of a recession and bolster arguments in favor of a less drastic pace of Fed rate hikes.

The federal funds rate futures market estimates a 75 bps rate hike in July with a probability of more than 70%. At the same time, the quotes imply that at the beginning of 2023 the rate will reach a peak of 3.3%, after which it will be reduced by 50 basis points until the end of next year.

As the Bloomberg analysis shows, when over the past 40 years the market expected a rate cut of at least 40 bps, then in the next 18 months a recession was coming in the United States.

"The markets say that a recession is coming, inflation will slow down, raw materials will fall in price, and the Fed will start cutting rates in 2023. This is a fairly consistent line, which can become a self-fulfilling forecast," the specialists of Winshore Capital Partners said.

The statistical data published ahead of the US showed that new orders for manufactured goods in the country rose more than expected in May, reflecting that demand for products remains high, even though the Fed is trying to "cool" the economy.

These data helped the US stock indexes, which fell by more than 2% during the session, to reduce losses. The S&P 500 even managed to get into the positive, increasing by 0.16% to 3,831.39 points.

The EUR/USD pair was also able to rebound slightly and closed near 1.0265, taking advantage of the fact that dollar bulls took a breather after a rapid rush to the upside.

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The greenback continued to push its main competitors on Wednesday. The USD index rose above 107, updating multi-year highs. At the same time, the euro fell below $1,0200 for the first time since December 2002.

The dollar has strengthened as energy prices are high and the Fed is raising interest rates faster than most other central banks, Credit Suisse said.

"We have traditional macroeconomic factors that are stimulating the strengthening of the dollar right now, rather than a risk-friendly movement," the bank's strategists said.

According to them, the United States is a net energy exporter, while Germany is facing a trade deficit for the first time since 1991.

"High interest rates in America and a trade shift that benefits the United States contribute to the steady strengthening of the dollar," Credit Suisse said.

Weak statistical data on the eurozone exerted additional pressure on the single currency.

Thus, retail sales in the currency bloc in May showed a modest increase of 0.2%, while orders from German factories in the same month decreased by 3.1%.

Meanwhile, the ISM index of business activity in the US services sector in June sank to 55.3 points from 55.9 points in May. However, this indicator turned out to be better than market expectations of 54.5 points, which supported the dollar.

In addition, the US currency continues to enjoy a flight from risks, as investors are increasingly worried about a global recession.

"The drumbeat is getting louder and louder about the risk of recession. Right now, defense is the name of the game. Now this is the best strategy, because during a recession, a lot can get out of control," said Vertium Asset Management analysts.

A reflection of the continued demand for security, seasoned with fears of recession and overheated inflation, is the fact that key Wall Street indexes are currently fluctuating between gains and losses.

Mizuho analysts note that the situation for risky assets remains uncertain at the moment.

In such conditions, the path of least resistance for the euro is a decline against the US dollar.

Further USD appreciation remains likely in the short term. The greenback can return to the peak of December 2002 at 107.30, and then to the high of October 2002 at 108.75.

As for the EUR/USD pair, its last pullback occurred due to the inability to cross 1.0280 (61.8% Fibonacci retracement level of the March-May movement). Even if the pair manages to overcome this level, it will need a resistance breakdown at 1.0360 to attract bulls. Next, the levels 1.0415 and 1.0525 can come into play.

On the other hand, the 1.0130 mark acts as the main buffer on the way to 1.0075 before the pair heads to the psychologically important 1.0000 level.

Viktor Isakov,
Experto analítico de InstaForex
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