The US dollar index follows the yield of treasuries, "redrawing" the picture in the main dollar pairs along the way. In particular, the yield of 10-year government bonds updated a two-year high today, reaching 1.806%. The last time the indicator rose in this area was in January 2020. Against the background of such trends, the greenback again spread its wings, returning the points lost on Friday. For example, the dollar partially "rehabilitated" against the euro: the greenback fell to 1.1367 after the release of Friday's Nonfarm. EUR/USD bulls tried to leave the 1.1260-1.1360 range, within which the pair has been trading for the sixth consecutive week. But in the wake of the controversial release, traders were only able to test the upper limit of this echelon. Bears have already seized the initiative at the beginning of this week, returning the price to the area of the 12th figure. De facto, traders returned to the "zero point" where they were on the eve of the release of Friday's data.
The increase in the yield of treasuries (and, accordingly, the dollar) is due to several fundamental factors. In the foreground are hawkish expectations, which have recently noticeably intensified. Let me remind you that at the very end of last year, the most important inflation release was published, which traders actually ignored. The core PCE index for November, which does not take into account volatile food and energy prices, jumped to 4.7% (in annual terms). This is the strongest growth rate since 1989 (!). At the same time, the October result was revised upwards (from 4.1% to 4.2%).
According to many experts, the indicator of price pressure of consumer spending is the "most preferred" for Federal Reserve members in the context of the analysis of inflationary processes. Therefore, the aforementioned release significantly strengthened the positions of dollar bulls (however, due to the specific New Year period, this report did not "shoot" at the time of release). The PCE report was a logical addition to another inflation report, which reflected a record increase in the consumer price index. Let me remind you that the November CPI similarly came out at the level of multi-year highs. The overall index accelerated to 6.8% y/y in November. This is the highest value of the indicator for the last 39 years.
The December figures should set another multi-year record (in particular, the overall index should reach 7%, the base indicator may grow to 5.4% y/y). The release is expected the day after tomorrow, that is, on Wednesday, so the dollar is in demand "in advance", in line with the trading principle "buy on rumors...".
In addition, on Tuesday, Fed Chairman Jerome Powell will take part in a hearing of the Senate Banking Committee regarding the approval of his candidacy for the post of head of the Fed. He is expected to comment on the latest macroeconomic reports and outline the prospects for tightening monetary policy this year. Traders will pick up subtle hints, paying attention to the accents placed. On one side of the scale is an unprecedented increase in inflation indicators, a 3.9 percent unemployment rate (the indicator dropped to a 22-month low) and a significant increase in average wages. On the other side of the scale is a weak increase in the number of employed and a significant decline in the ISM indices in the manufacturing sector and in the service sector.
Powell can focus either on the existing risks or on the need to raise the interest rate, given the dynamics of inflationary growth. Let me remind you that the minutes of the Fed's December meeting published last week announced two main messages: 1) current macroeconomic conditions may lead to an earlier start of the rate hike cycle; 2) the rate of increase may be "faster than previously expected." If Powell also voices these messages, the dollar will significantly strengthen its position and, paired with the euro, will be able to break out of the range of 1.1260-1.1360.
The main trump card of the dollar is the divergence of the European Central Bank and the Fed rates. This is the main argument, thanks to which EUR/USD will be able to return to the base of the 12th figure in the future, and to the one-and-a-half-year price low (1.1186). The uncorrelation of the positions of central banks is already visible – the Fed has begun to curtail QE, while the ECB at the last meeting ruled out the option of an early resolution of this issue: the PEPP program will be completed next spring. Moreover, ECB members will increase the volume of the APP program, which they have extended with an open completion date. As for the fate of the interest rate, the correlation is more pronounced here. The Fed will certainly begin a cycle of tightening monetary policy this spring (in May or even in March), while the ECB has ruled out the option of considering this issue within the current year.
In addition, the dollar is in high demand amid a decrease in risk appetite. Omicron continues to actively "walk around the planet", setting new and new anti-records. At the same time, the World Health Organization warned that the current highly contagious version of the coronavirus "is unlikely to be the last." Against the background of this message, information appeared that a new strain of Covid was discovered in Cyprus. According to local virologists, we are talking about a hybrid of Delta and Omicron. The new modification has already been given a conditional name - "Deltacron". And although this information has not yet been confirmed by WHO experts, anti-risk sentiment in the market has nevertheless increased. The beneficiary of the situation was the dollar, which is used as a protective tool. Indirect support for the greenback in this regard was provided by US President Joe Biden, who the day before yesterday said that the United States have already developed and continue to develop means to combat the virus, "capable of resisting various strains." At the same time, he once again ruled out the option of a nationwide lockdown: the White House is betting on a vaccine campaign.
Thus, taking into account the prevailing fundamental background, short positions on the EUR/USD pair are still a priority. The growth of key inflation indicators, the possible tightening of the rhetoric of the head of the Fed, as well as a decrease in the unemployment rate against the background of rising wages help the dollar to "stay afloat." If Powell really tightens his rhetoric, and the inflation release comes out in the green zone, the pair may overcome the lower limit of the range of 1.1260-1.1360 and go to the base of the 12th figure.
