When American exceptionalism turns into doom, the US dollar has nothing left to do but flee the battlefield. In Forex, there is a growing opinion that only the US will face a recession in 2023, while the eurozone will manage to avoid an economic downturn, and China will be vigorously recovering. This is in stark contrast to last year's events when, due to the armed conflict in Ukraine and the energy crisis, the currency bloc was on the verge of collapse, and EURUSD fell below parity for the first time in 20 years. Today, the market has different realities.
The release of US retail sales data only heightened investors' concerns about a significant slowdown in GDP. The indicator shrank for the second consecutive time, significantly stronger, at 1% MoM, than Bloomberg experts estimated. If consumer spending collapses following the crisis in the real estate and banking sectors, a recession will become inevitable. The Federal Reserve will have to make a dovish pivot in 2023, no matter what the central bank says otherwise. This will weaken the US dollar.
Dynamics of retail sales in the US
Markets are currently set for a 25 basis point increase in the federal funds rate in May, followed by a 75 basis point decrease in the second half of the year. Such a balance of power became possible after consumer prices slowed from 6% to 5% and the first slump in producer prices in two years on a monthly basis. US inflation is clearly slowing down, allowing investors to argue that the Fed has done its job and the monetary tightening cycle is nearing its end.
In Europe, the picture is different. There, European Central Bank officials are very aggressive amid record core inflation levels. It needs to be broken, and the short-term market predicts a further 75 basis point increase in the deposit rate, to 3.75%. At the same time, derivatives believe that at the next Governing Council meeting in May, the cost of borrowing will increase by 31 basis points. So the chances of +50 basis points still remain, which contributes to the rise in EURUSD quotes. In terms of the interest rate swap market, the euro is still undervalued compared to the USD.
Dynamics of EURUSD and interest rate swap differentials
In my opinion, the decline in the main currency pair in response to the disappointing US retail sales data is the result of speculators taking profits on long positions after a sharp EURUSD rally throughout the week leading up to April 14. When everyone is buying, there is an excellent opportunity to sell, so there is no need to be surprised by the seemingly unexpected strengthening of the US dollar. It's just the peculiarities of trading.
Technically, on the daily chart, EURUSD bounced off the upper limit of the fair value range at 1.0675-1.0975. No asset can grow indefinitely, and the correction seems like a necessary breather. At the same time, the uptrend persists, and a bounce off support levels at 1.097 and 1.09 should be used to establish long positions.
