Yesterday, another inflation report was published in the U.S., which, in theory, should have provided additional support to EUR/USD buyers. It concerns the producer price index, which ended up in the "red zone," reflecting a slowdown in inflation in the States. This fact is not in favor of the greenback, but given the circumstances, the release has taken a back seat.
The dollar is strengthening its positions against the backdrop of growing risk-off sentiments. The news of the day (crisis in the banking sector, threat of a default on the national debt, geopolitical tensions) allows EUR/USD sellers to ignore even the most important macroeconomic reports. However, these releases will make themselves known when the situation stabilizes and classical fundamental factors return to the fore.
PPI in the red
The Producer Price Index announced on Thursday again ended up in the "red zone," falling short of forecast levels. The overall index on an annualized basis came in at 2.3%, with a forecast decline to 2.5%. This is the weakest growth rate since January 2021. The indicator has been consistently decreasing for the tenth month in a row. The core producer price index, excluding food and energy prices, also fell significantly at 3.2% (the weakest growth rate since March 2021). This component of the report has been decreasing since April last year.
Following the publication of two inflation reports, the market has formed its position regarding the June meeting of the Federal Reserve. Thus, according to the CME Group FedWatch Tool, the likelihood of another round of 25 basis point rate hikes next month is only 9.6%. Accordingly, the chances of maintaining the status quo is 90.4%. This is largely due to the fact that core inflation did not accelerate in April, contrary to the respective fears.
Note that over the preceding five months, the core index was consistently decreasing (from 6.6% to 5.5%). But in March, the growth rate of the core CPI accelerated for the first time in half a year. This fact strengthened the positions of dollar bulls: the market began to talk about the fact that if the core index continues to pick up, the Federal Reserve will have to take responsive measures. However, in April, the core indicator returned to 5.5%.
Against the backdrop of a decrease in other components of the reports (CPI and PPI), the market has come to a justified, in my opinion, conclusion that the Federal Reserve will definitely maintain the status quo not only at the June meeting but also at the July meeting. Incidentally, according to the same CME Group FedWatch tool, the likelihood of a 25-point rate cut at the July meeting is as much as 37%. The chances of maintaining a wait-and-see position are 54.7%, while a 25-point rate hike is only 8.4%.
As you can see, traders' hawkish expectations have significantly weakened against the backdrop of the latest inflation reports. But all these circumstances, as they say, "shine, but do not warm" EUR/USD buyers. Despite the decline in hawkish expectations, the dollar continues to gain momentum across the market.
The Market is Anxious, the Dollar is Growing
The greenback is currently in high demand as a safe-haven asset. The threat of a U.S. government debt default and the ongoing banking crisis support the safe dollar, while all other fundamental factors have taken a back seat.
For example, this week, it became known that another American bank has entered the risk zone: regional creditor PacWest announced a loss of nearly a tenth of its deposits in the first week of May. The bank's market capitalization is $577 million, and it seems that it may join the previously bankrupt Signature Bank, Silvergate, Silicon Valley Bank, and First Republic Bank. In light of renewed fears about the state of regional U.S. banks, the dollar has strengthened its position as a safe-haven instrument.
Another cause for concern is the potential default of the U.S. As you know, on June 1, the country's government may default on debt if Congress is unable to raise the upper debt limit to $31.4 trillion. Negotiations between Republicans (who control the House of Representatives) and Democrats (who control the Senate and whose representative heads the White House) stalled this week.
U.S. President Joe Biden and Treasury Secretary Janet Yellen have already warned of the catastrophic consequences of a default, but, as they say, the cart is still stuck there. Democrats insist on raising the debt ceiling without any additional conditions or reservations. Representatives of the Republican Party demand to cut government spending in exchange for supporting an increase in the limit. There are only 2.5 weeks left until June 1, and politicians will likely keep the market on edge until the last moment. The market, in turn, reacts sharply to such risks, so the safe dollar is growing despite all other fundamental factors.
Conclusions
The EUR/USD pair is falling due to the overall strengthening of the U.S. currency. The greenback has become a beneficiary of the current situation and is reaping the benefits amid heightened risk-averse sentiments. The danger of the situation is that market sentiment can change abruptly under the influence of external factors (for example, if congressmen do find a compromise and raise the debt ceiling). At the same time, many fundamental factors currently ignored by traders are not in favor of the U.S. currency. For instance, the Producer Price Index published yesterday served as another confirmation that inflation in the U.S. is slowing down. This release will definitely remind of itself once American politicians find a compromise solution and regulators put out another fire in the banking sector. But for now, other fundamental factors are in the spotlight.
Given such a high degree of uncertainty, it would be prudent to maintain a wait-and-see stance on the EUR/USD pair, as the downward price dynamics are more likely emotional rather than objective factors. In such conditions, it is safest to stay out of the market.
