The US currency gained about 9% in the period from February 24 to mid-May. This was largely facilitated by the demand for protective assets caused by the Russian-Ukrainian conflict.
In addition, investors put in quotes a scenario according to which the rate hike in the United States will go faster than in other major economies.
However, having touched an almost two-decade high just above 105 on May 13, the greenback was forced to slow down its progress.
The fact is that the central banks, who were late to the party, signaled that they were trying to catch up and were preparing their own campaigns to tighten policy.
On Monday, European Central Bank President Christine Lagarde announced that the bloc's eight-year life with negative interest rates will end by September.
This led to the fact that the difference in exchange rates between the Federal Reserve and the ECB, which was used by the dollar, decreased slightly, and that is why we saw that the euro experienced some relief.
"The ECB's recent hawkish shift helped provide much-needed support for the single currency after it briefly tested the low of the beginning of 2017 at $1.0340. Since then, the euro has experienced a relief rally, returning to the middle of our forecast range of $1,0300-1,1100," MUFG Bank analysts said.
Money markets are still forecasting a rise in interest rates in the United States by about 175 basis points by the end of the year. But now they also estimate an increase in ECB rates by about 100 bps against the 20 bps observed immediately after the start of Russia's special operation in Ukraine.
MUFG Bank strategists point out that, for the most part, the tightening of the Fed's policy is already embedded in prices. They still expect the greenback to weaken more noticeably at the end of the year.
BNP Paribas analysts hold a similar opinion, who believe that the Fed's rate cycle is now being evaluated fairly.
"If the market does not see a new jump in US interest rates, the dollar will decline as investors resume carry trades," they said.
Fed members, including its chairman Jerome Powell, recently laid out the red carpet for two rate hikes of 50 basis points at the next two meetings of the central bank, after which, according to a number of politicians, the Fed will need a respite to reassess the threat of entrenching inflation.
One of the last Fed officials to support the idea of a pause was Atlanta Fed President Rafael Bostic.
"I have an initial point of view, according to which a pause in September may make sense," he said.
This statement followed comments by Kansas City Fed President Esther George, who on Monday supported the view that the Fed should reconsider the situation after raising rates by 50 bps both in June and in July.
Cooling expectations of aggressive rate hikes in the United States hurt the US currency, which fell by about 1.2% in the first two days of this week.
According to widespread opinion, the greenback strengthens ahead of the Fed's rate hike, and then begins to fall. According to Refinitiv, in three of the last four US rate hike cycles, the USD index has declined by an average of 1.4% between the first and last rate hike.
Some experts believe that this story will repeat itself again.
"The US currency is on its last legs, and when the denouement comes, we expect a multi-year weakening of the dollar," Key Square Group strategists said.
The achievement of USD multi-year peaks on May 13 coincided with an increase in speculative long positions in the US currency to more than $20 billion. However, since then, dollar bulls have somewhat loosened their grip.
JPMorgan analysts note that currency markets are reacting to the transition from the exclusivity of the United States to a global slowdown that will affect America as well.
"Over the past two weeks, we have witnessed some deterioration in the macroeconomic situation, which has begun to manifest itself in corporate earnings and economic reports," U.S. Bank Wealth Management said.
Statistical data published the day before indicated a weakening of economic momentum in the United States.
So, on Tuesday it became known that sales of new homes in the country in April fell by 16.6% compared to the previous month, to 591,000, which is the worst indicator since April 2020.
A separate report reflected that the composite index by the purchasing manager in the United States amounted to 53.8 points in May compared with 56 points recorded in April. The growth rate of the indicator was the slowest in four months.
These releases have increased concerns that if the Fed significantly tightens monetary policy, it could lead the US economy into recession.
As a result, the USD index sank by 0.4% on Tuesday, reaching its lowest level since April 26 in the area of 101.76.
The stable US economy and the unfavorable geopolitical situation in the world have created ideal conditions for the growth of the dollar, but they are giving way to a "soft" environment in which the risks of an economic downturn become obvious, analysts at Millennium Global say.
They expect that the fall of the US currency continues, however, they believe that calling the recent high a peak for the USD is a very serious challenge.
ING analysts believe that a prolonged reversal or correction of the greenback is unlikely.
"We do not expect a sharp downward correction for the broad dollar trend – mainly because the Fed has the main reason for a sharp increase in rates," they said.
The Fed changed its course too late and was too dovish. Now the only way to cool inflation is to pursue monetary policy decisively, according to Pershing Square Capital Management analysts.
Expectations for a Fed rate hike may change after the central bank's June meeting, ING notes.
"Everything may change at the next FOMC meeting on June 15-16 if the dot charts show rates at 3%+ at the end of 2023. But there are three weeks left before this meeting," the bank's strategists said.
The USD index, which lost more than 1% in the first two days of the week, is adding about 0.5% on Wednesday, trading around 102.30 points.
The greenback gained some stabilization ahead of the release of the minutes from the Fed's May meeting.
MUFG Bank analysts believe that the minutes may present a hawkish surprise if the central bank discusses the possibility of an even more aggressive increase in the key rate to curb inflationary pressure, and this will push the dollar up.
Powell talked about two rounds of 50 bp increases, but rejected a larger step.
The minutes may demonstrate the desire of a number of FOMC members to leave the door open for a 75 basis point rate hike.
Another hawkish turn may be that some politicians, or even most, will propose actively selling mortgage-backed securities (MBS) to cool the booming housing market. This would mean withdrawing money from the markets at a faster pace.
The next key support for the USD is at the level of 100.89 (55-day moving average), which the US currency must hold in order to stay in the new range and avoid a potentially deeper fall to 100.50-100.00, according to Credit Suisse economists.
"The medium-term momentum picture remains favorable, and therefore we adhere to our medium-term bullish forecast and expect a rise above 103.82 after a potentially prolonged consolidation, before moving above the recent high at 105.01. A sustained break above 105.01 will signal an increase to 109.25-110.25 in the long term," they said.
The resumption of the dollar's strengthening on Wednesday led to the fact that the EUR/USD pair lost its positive momentum after reaching the highest level in a month in the area of 1.0750 on Tuesday.
On Wednesday, the pair sank by more than 90 points from the last closing level of 1.0735, then it was able to reduce losses somewhat. Currently, the pair is trading at 1.0700, trying to determine the direction of movement.
"The euro's ability to extend its recent advance much further amid the normalization of ECB policy is still limited by the continuing downside risks from the conflict in Ukraine. Now it seems increasingly likely that the conflict will be longer than initially expected, and thereby increase the risk of a longer period of disruptions for the eurozone economy, which will restrain growth and keep inflation higher for longer," analysts at MUFG Bank said.
Given that the markets have already included in the prices an ECB rate increase of 100 bps by the end of the year, consolidation looks more likely than the continuation of EUR/USD growth in the area of 1.0800-1.0900, ING strategists believe.
The slowdown in global economic growth is likely to provide the dollar with good support. Accordingly, the EUR/USD pair will decline to 1.0300 in the coming months, Rabobank predicts.
"Despite the recent EUR/USD rally, we still note the likelihood of another attempt to decline in the future from one to three months.
Concerns about slowing economic growth in the United States and Europe are supplemented by concerns about growth in the Middle Kingdom. Against the background of the country's commitment to a zero tolerance policy for COVID-19, forecasters have consistently revised China's GDP growth expectations in recent months," the bank's analysts said.
JPMorgan again sharply lowered its forecast for economic growth in China. The bank now expects a 5.4% decline in national GDP in the second quarter against the previous estimate of -1.5%. UBS has revised its forecast for Chinese GDP for 2022 from 4.2% to 3%. Recall that the official forecast of the Chinese authorities is about 5.5%.
"The risks to global economic growth suggest that demand for safe haven assets is likely to remain high and the dollar will remain strong for a longer time. Therefore, EUR/USD will head towards the 1.0300 area again in the coming months," Rabobank reported.
