The results of the July FOMC meeting did not bring any surprises and caused a wave of optimism in the financial markets.
Key Wall Street indicators ended trading on Wednesday with an active growth.
In particular, the S&P 500 jumped 3.9% to 4,023.61 points, recording the largest one-day percentage gain since April 2020. The index closed at its highest level since June 8.
Meanwhile, the greenback lost almost all the points scored on Tuesday and Wednesday.
Ahead of the announcement of the Federal Reserve's verdict on monetary policy, the USD index was trading just above 107.00 points, adding about 0.1%.
However, after the central bank raised the key rate by 0.75%, to 2.25-2.50%, the greenback plunged by 0.75% to 106.30 points, demonstrating the largest one-day percentage drop since July 19.
The market breathed a sigh of relief, as there were some concerns about raising the federal funds rate by 100 bps at once.
"Hopes for a slower pace of rate hikes have led to lower expectations for additional rate hikes, falling bond yields, tightening credit spreads and rising stock prices," said strategists at Allspring Global Investments.
Expectations of a 50 basis point increase in borrowing costs at the September FOMC meeting rose to 60.9%, according to CME Group, compared with 50.7% on Tuesday, while forecasts of a 75 basis point hike in the key rate by the central bank fell to 35.2% from 41.2%.
Amid a surge in risk sentiment, the dollar was under selling pressure. Apparently, investors who were waiting for the federal funds rate to rise by 100 bps decided to lock in profits.
In addition, traders reduced long positions in the US currency as they overestimated the final rates in the United States.
Futures on the federal funds rate now take into account its growth in prices by the end of the year to 3.4%.
A month ago, interest rate expectations were more aggressive and assumed an increase in rates this year to 3.8%.
The US stock market showed a rally on Wednesday, and the protective greenback fell after Federal Reserve Chairman Jerome Powell acknowledged that the national economy is slowing down and suggested that the central bank may slow down the pace of rate hikes in the coming months.
"The Federal Reserve is ready to switch to a moderately restraining monetary policy rate, and by the end of this year the rate may reach 3-3.5%," the head of the Fed said.
Market participants are now wondering whether the Fed has reached the peak of its aggressiveness in raising rates.
Some investors say they are ready to increase risky positions again, believing that the end of monetary tightening in the US, which has damaged the stock market, is finally in sight after the Fed raised rates by a total of 225 basis points.
Robeco Asset Management analysts said that the FOMC meeting in July strengthened their confidence that policymakers would bring inflation under control.
"It seems that a slowdown in the pace of monetary policy tightening by the Fed would be possible, given what we heard today," Blackrock analysts said on Wednesday. They expect a rate hike of 50 basis points at the September meeting of the US central bank and one or two more increases of 25 bps after that.
"We think that the Fed has in some way caught up. At least they convinced the markets that they understood the seriousness of the situation and acted accordingly," KBRA strategists said.
Following the results of trading on Wednesday, US stocks rose significantly in price, and the USD index approached a three-week low, since the recent downward correction of expectations regarding the speed of the Fed's rate hike can be considered as a support factor for risky assets.
However, many investors fear that inflation will be stable and will force the US central bank to maintain a hawkish position at least until next year.
According to Powell, Fed officials are acutely aware of the difficulties that American households face due to high inflation, and will not weaken their efforts until convincing evidence is presented that inflation is declining.
At the same time, Powell did not give specific instructions on what to expect from the central bank next, hinting only that subsequent decisions will depend on incoming data.
"A lot still depends on inflation and the ability of the US central bank to return it to the target of 2%," Allspring Global Investments believes.
Citi analysts see core inflation pushing the Fed to raise rates more aggressively than markets expect, with a 75 basis point hike in September.
"There are almost two months left until the next FOMC meeting – the period when two employment reports, two inflation reports will be released and the Fed symposium will be held in Jackson Hole. A lot can happen during this time, so it's not surprising that the central bank's forecasts are somewhat uncertain," ING strategists noted.
A less hawkish than expected decision of the Fed on monetary policy, announced the day before, led to an increase in key Wall Street indices.
However, according to a number of experts, investors should maintain a defensive position due to the threat of further tightening of the Fed's policy and capital outflow from the market. They believe that any stock rebound will not be sustainable in the long run. And in the best case, it will be a short rebound, because the results of corporate profits in the second quarter are not particularly impressive yet, and the third quarter may be even worse, since macroeconomic data may deteriorate even more.
On Wednesday, Powell made it clear that a further slowdown in economic growth is necessary to reduce inflation, and restoring price stability is now an absolute priority for the central bank.
"We would not hesitate to raise the rate more, but we decided that, taking into account the available data, it would be appropriate to raise it by 75 bps. A more active rise may take place at one of the future meetings, if the incoming data are conducive to this," he said.
According to FactSet, the profit growth of companies included in the S&P 500 index averaged 4.8% after the publication of reports of 21% of companies.
"If 4.8% becomes a real profit growth after the end of the season, the indicator will be at the lowest level since the fourth quarter of 2020 (4%)," FactSet representatives said.
Analysts also warned investors not to wait for a tipping point for the dollar, as any pullback of the US currency is likely to be a pause.
"A slower Fed rate hike may put pressure on the dollar in the medium term. But over the next month or two, there will be a lot of global risks (for example, China, Ukraine / Russia / European energy, Italy) that should limit the dollar's fall, so you should not get too carried away with selling the US currency," Westpac analysts believe.
Wells Fargo strategists still forecast the strengthening of the US dollar against most major currencies until the beginning of 2023.
"In the coming months and quarters, we will be closely watching for further signs that the peak of inflation and the peak of interest rates in America are already close.
In the short term, we believe that market conditions are still contributing to the strengthening of the dollar, and we maintain the corresponding forecast until the end of this year," they said.
"If inflation shows more concrete signs of reaching a peak, and expectations for a Fed rate hike decrease even more, the greenback may reach a peak earlier than we currently predict. At the moment, we believe that the trade-weighted USD exchange rate is likely to peak in the first quarter of 2023 and will decline over the next year as the Fed discusses, signals and eventually reduces interest rates," Wells Fargo added.
The bank's analysts noted that they began to evaluate the prospects of the euro less constructively.
"Since the eurozone is currently expected to fall into recession and the ECB is likely to pursue a relatively limited monetary tightening cycle, we expect the EUR/USD rate to fall to 0.9600 or lower," Wells Fargo said.
Ahead of the Fed's interest rate decision, the main currency pair plunged to 1.0100 on Wednesday, losing about 0.18%, amid disappointing data on Germany.
According to the Gfk report, the consumer climate index in the country for August amounted to -30.6 points compared to -27.7 points in July and the forecast of -29.0 points.
Taking advantage of the fact that the dollar lost its positive momentum after Powell's comments, the EUR/USD pair rose by almost 100 points at the end of the US session and finished around 1.0200.
"The fact that the dollar has fallen still means the beginning of a serious reversal. Like the Fed, we are also now in data monitoring mode," Credit Suisse analysts said.
Further signs of a slowdown in the US economy are likely to further strengthen the market's opinion that there are several months left before the peak of the rate hike cycle in the United States, which will potentially deprive the greenback of momentum for growth.
Based on this, one would expect an increase in the EUR/USD exchange rate, but it is also necessary to take into account the euro side in the equation.
"At the moment, the market is working with the idea that a slowdown in economic growth will make the Fed blink and that the United States is entering a recession. However, in order to get a weak dollar, you need a strong euro, and this will not happen yet, given the headwinds that Europe is facing," TD Securities strategists said.
At the beginning of the European session on Thursday, the EUR/USD pair continued to move up and rose to 1.0230. At the same time, the USD index plunged below the level of 106.00 points, still playing back the Fed's statements on monetary policy.
Then the EUR/USD pair turned to decline and reached a local low around 1.0120. This happened after the European Commission reported that consumer confidence in the eurozone fell to -27 points in July from -23.8 points in the previous month."The indicator of consumer sentiment in the eurozone fell sharply in July, and forecast indicators point to an economic downturn in the second half of the year," ING analysts noted.
"Although we still believe that the ECB will provide an additional 50 bp rate hike in the coming months, the specter of a full-blown recession is likely to stop the tightening cycle before the end of this year," they added.
On Thursday, ECB Governing Council member Ignazio Visco said that the central bank may refrain from another significant interest rate hike in September. "What we see in the real economy is certainly not very encouraging," he said.
In July, the ECB raised interest rates by 50 basis points and made it clear that further increases were coming.
"The window of opportunity for the ECB to continue raising rates is closing as the economy weakens," analysts at BNP Paribas believe.
For the euro exchange rate, the size of the ECB rate hike matters, and the reduction of expectations regarding the increase in the cost of borrowing by the central bank can put pressure on the single currency.
At the same time, the worst scenario for the European Central Bank will be stagflation, when interruptions in Russian gas supplies will cause a recession in the eurozone, while the energy crisis and a weaker euro will continue to push consumer prices up.
The data to be published on Friday is likely to show that consumer prices in the eurozone rose to a new record of 8.7% in July.
The first estimate of the currency bloc's GDP for the second quarter will also be published tomorrow, which, according to forecasts, will reflect an increase in the indicator by 0.1% compared to the previous quarter. This marks a sharp deterioration from the 0.6% increase in the previous three months.
While growing concerns about gas and energy shortages in the eurozone continue to weigh on the euro and threaten the ECB's ability to tighten policy, the greenback continues to benefit from its safe haven asset status and the Fed's still favorable position.
The USD index managed to turn around after a strong pullback on Wednesday and jumped to 106.80 points on Thursday.
The dollar remained on an upward trajectory even though the US GDP in the second quarter of 2022, according to the first estimate, fell by 0.9% in terms of the year. Analysts expected, on the contrary, the growth of the American economy by 0.5%.
On the side of USD bulls is its protective status, because, as you know, when America sneezes, the whole world catches a cold.
So far, bears' attempts to push the greenback lower are limited to the area of 106.00.
Bouts of additional weakness of the greenback may lead to its decline to the 55-day moving average of 104.70.
However, while USD is trading above the five-month support line around 103.90, the short-term prospects look constructive.
The broader bullish outlook remains in effect as long as the dollar is above the 200-day moving average at 99.35.
As for the EUR/USD pair, the nearest support is located at 1.0105, and further – at 1.0070 1.0020.
On the other hand, the initial resistance is marked at 1.0205, followed by 1.0240 and 1.0280.
