The greenback fell correctively against its main competitors on Tuesday, including the euro, after two consecutive days of growth.The USD index ended yesterday's trading at 103.50, having decreased by 0.12% during the day.
Recall that at the end of last month, the US currency has largely strengthened and has broken several long-term records.
A noticeably heavier dollar and the prospect of an increase in the cost of borrowing in the United States hit the global financial markets. As a result, the S&P 500 has just posted its worst January-April performance since the 1930s. Since the beginning of this year, the index has dropped by almost 14%.
The sharp drop in the stock and bond markets in 2022 is due to the upcoming transition of the Federal Reserve from quantitative easing to quantitative tightening, Bank of America analysts said.
According to them, the drawdown of the S&P 500 below the 4,000-point mark will be a turning point that can provoke a massive outflow of investors' funds from the US stock market.
"Two years of pandemic-induced quantitative easing worth about $11 trillion worldwide are coming to an end, and the anchor of market volatility has been lifted," Bank of America said.
The day before, the yield on 10-year US Treasury securities exceeded the 3% mark, after which it fell to 2.957% compared with 2.995% on Monday. Yields, which move inversely with bond prices and serve as a benchmark for the cost of borrowing in the economy, have reached the highest levels since 2018.
Meanwhile, key Wall Street indexes ended yesterday's trading higher after a turbulent session during which they fluctuated between profit and loss, as the two-day FOMC meeting kicked off on Tuesday.
"The number one driving force behind all the market volatility over the past few months has been the hawkish rhetoric of Fed officials, so getting an update from them on Wednesday is the main catalyst, and we think the market is now in standby mode," Baird strategists said.
Optimistic data on the United States, published the day before, made it possible for the main Wall Street indices to close in the black.Thus, production orders in March expanded by 2.2% on a monthly basis, twice exceeding the expected growth of 1.1%.
A separate report showed that the number of open vacancies in the United States increased by 205,000 in March compared to the previous month and reached a record 11.549 million. Analysts on average predicted a reduction in the number of vacancies to 11 million.
This report helped the dollar to win back most of the intraday losses. Nevertheless, the USD index ended Tuesday's trading in negative territory. The euro did not fail to take advantage of this, which rose to $1.0525, strengthening by 0.16% during the day.
On Wednesday, the greenback moved further away from the 20-year highs marked at the end of last week at the level of 103.90.Meanwhile, the EUR/USD pair is developing Tuesday's growth, and the main US stock indexes are trading in the red zone today, losing about 0.6% on average, as market sentiment remains cautious ahead of the announcement of the Fed's monetary policy verdict.
The central bank is expected to raise interest rates by half a percentage point on Wednesday and announce the start of reducing its balance sheet by $9 trillion.
The US central bank is likely to raise its key rate by 50 bps today. In this case, the dollar may rise slightly, according to Commerzbank.
"The greenback may benefit from the rate decision in the short term, as there will probably be some market participants who expect a smaller increase of 25 bps," the bank's specialists said.
"Expectations for the rate have already come a long way. Therefore, the market may be disappointed, and the dollar will decline correctively. However, events in connection with the conflict in Ukraine are likely to limit the possible bearish correction in USD," they added.
Money markets put into quotes the probability that the Fed will raise the key rate to 3.6% by the end of 2023 in order to tame inflation, which is at a 40-year high.
Traders also estimate an almost 100% chance of a 75-point rate hike at subsequent FOMC meetings in mid-June and 50 points at the end of July. The United States experienced such a sharp increase in rates for the last time in the 1980s.
Since no new economic or political forecasts are expected before the central bank's June meeting, most of the clues about how far and how fast it is ready to go will come at a press conference from Fed Chairman Jerome Powell.
The central bank's plan to reduce its balance sheet will also be in the spotlight on Wednesday. Although the broad outlines were revealed about three weeks ago in the minutes from the Fed's March meeting, investors want to know details about the speed and scope of the plan, including possible sales of mortgage-backed securities (MBS) at some point in the future.
"We believe that the FOMC will provide a 50bp rate hike, and a 75bp hike is not completely ruled out, but is unlikely at this stage. We expect that the beginning of quantitative tightening will be announced today. The Fed is likely to start with $50 billion going out every month before this process accelerates to $95 billion by September. All these measures should generally meet market expectations. This, however, does not mean that there is no room for surprises on both sides," ING economists said.
In their opinion, any downside risk for the dollar seems limited.
"A serious correction of the dollar will occur only if the Fed resists hawkish pricing in the market, and until they do, the markets have a certain degree of freedom to revise the final rate to 4%," ING reported.
"We are also in a situation where if you give up dollar positions, you will have few places where you could invest your money," the bank's strategists said, noting the impact of the Russian-Ukrainian military conflict on Europe and the slowdown in economic growth in China.
These factors led to the fact that last week the euro fell to the lowest levels in two decades around $1.0470.Currently, the EUR/USD pair is struggling to extend the rebound above the key support of 1.0500.
However, the basic bearish mood in the pair remains, so it is impossible to exclude another visit to multi-year lows. At least as long as EUR/USD is trading below the 3-month support line around 1.0970, additional losses remain likely.
"The euro's recovery will probably require changes in the European Central Bank's policy statement, but the timing of this remains uncertain (the next meeting will be held on June 9). Until this happens, the EUR/USD pair remains in danger of falling below 1.0500," ING analysts believe.
A similar opinion is shared by Carmignac specialists.
"Fundamental factors, the difference in interest rates, growth prospects, the desire to abandon risk – all this plays in favor of the greenback," they said.
"Many factors point to the strengthening of the dollar and the weakening of the euro. Therefore, we have increased our positions in the US currency in our global portfolio," Carmignac noted.
Some experts expect the first rate hike from the ECB this year, which will support the single European currency.Currently, money markets estimate a 97 basis point rate hike in the eurozone by the end of the year.
The last time the ECB raised rates was in 2011 and since 2014 has kept the base deposit rate, which is now -0.5%, in negative territory.
"Talking alone is no longer enough, we need to act. In my opinion, a rate hike in July is possible," ECB board member Isabelle Schnabel said on Tuesday.
However, it will be very difficult for the ECB to keep up with the Fed, since traders have already put in quotes an increase in US interest rates by half a point later today and by about 250 basis points in the rest of the year.
The EUR/USD pair was able to gain momentum on Wednesday, rising to 1.0555, as disappointing statistics on the United States weakened the dollar's appeal.
According to ADP data, the number of jobs in private companies in the United States increased by 247,000 in April, while an increase of 395,000 was expected. In addition, the country's trade deficit increased by $20 billion in March, or 22.3% compared to the revised February figure, to $109.8 billion, although it was previously forecast to increase to $107 billion.
Since the beginning of the week, the EUR/USD pair has been trying to determine the direction of movement, as the markets have come to a turning point in anticipation of an important decision by the Fed for several decades.
It depends on this decision whether we have already witnessed the formation of the greenback peak or whether it still has opportunities for further growth.
According to a recent poll conducted by Bloomberg, most economists predict a 50 bp hike in the Fed's key rate. Both May and June. In their opinion, by December this year it will reach 2.25-2.5%.
Meanwhile, Nomura analysts suggest a 75bp rate hike following the results of both the FOMC meeting in June and July.
If Fed officials think that the next rate hikes shouldn't be so aggressive, stocks have a good chance of rallying against the dollar.Moreover, if Powell takes a cautious tone on future rate hikes, the greenback is likely to come under selling pressure and help EUR/USD move higher.
On the other hand, Powell's signals about raising rates by 75 bp in upcoming meetings to curb inflation could be seen as extremely hawkish.
These comments will strengthen market expectations that interest rates in the US may exceed the neutral level before the end of the year. In this case, the dollar will get grounds for subsequent strengthening.
In this scenario, the next upside barrier for the USD index is expected to be at a 20-year high just below 104.00 (April 28) ahead of 105.60 (Dec 11, 2002 high).
The current bullish position in the index is still supported by the 8-month line near 96.80.
The greenback is expected to remain constructive as long as it trades above the 200-day MA at 95.85.
As for the EUR/USD pair, it will need to overcome the 1.0560 resistance to attract bulls and continue its recovery. Above this, resistance lies at 1.0600 (50-day moving average), then at 1.0660 (38.2% Fibonacci retracement).
Meanwhile, the round level of 1.0500 can be seen as intermediate support ahead of 1.0470 (multi-year low on April 26) on its way to 1.0420.
