23.02.202309:26 Forex Analysis & Reviews: EUR/USD: the dollar plays with muscle, showing strength, and the fallen euro looks dull

The U.S. currency showed significant growth, based on the minutes of the latest meeting of the Federal Reserve. This weighed on the euro, which started to rapidly decline. But the single currency is trying to stay afloat despite the jubilant and steadily rising EUR/USD rival.

The minutes of the Federal Reserve meeting were released on the evening of Wednesday, February 22. Recall that it summed up the results of the Fed meeting, held on January 31 - February 1, 2023. The greenback surged after this report, approaching the February highs. At the same time, the euro considerably fell, trading below 1.0600 for the first time since the beginning of January this year.

According to the current data reflected in the FOMC minutes, some officials support further rate hikes. At the same time, they allow the hike (from 25 bps to 50 bps) to be raised further, although recently the issue of slowing down the pace of rate hikes was raised. However, the situation has now changed and a number of FOMC representatives are in favor of increasing the interest rate by 50 bps.

According to analysts, such statements are caused by the Fed representatives' confidence that a considerable increase contributes to bringing inflation closer to the 2% target and will help to achieve the central bank's restrictive policy. The Bank believes that a sustained rate hike is the most appropriate way to achieve the Fed's twin goals of maximum employment and inflation at 2% over the long term.

The central bank intends to stick with restrictive monetary policy until current economic data shows a sustained decline in inflation to the 2% target. The FOMC minutes emphasize that inflationary pressures have now abated, but price growth is still above the 2% target. In addition, the U.S. labor market remains tight, which adds pressure on wages and prices.

Against this background, the U.S. currency is feeling confident, unlike the euro. The latter continues to decline, giving way to the USD. On Wednesday the euro also declined after the release of German inflation data. As a result, EUR/USD dropped to 1.0635 from the previous level of 1.0646. Note that before the release of the German inflation report, the situation was reversed: The euro appreciated against the US currency to 1.0660. Later on, the pair was balancing on the brink of slump and rise, approaching the lows of January. On the morning of Thursday, February 23, EUR/USD traded near 1.0627, trying to move beyond the current range.

According to experts' final assessment, the annual inflation in Germany in January accelerated to 8.7% from the previous 8.6%. Market participants also assessed the ifo Business Climate Index, which rose to 91.1 points in February, up from 90.1 points in January.

According to analysts, tighter monetary policy on the part of the European Central Bank and the Bank's hawkish rates will help the euro reduce its current losses. This is aided by the release of optimistic data on PMIs in Germany and EU countries. Note that the yield of German 10-year government bonds rose by 3% and stabilized above 2.5%. At the same time in September, experts expect the ECB deposit rate to increase to 3.75%. At present the figure is 2.5%.

Earlier Deutsche Bank's currency strategists reviewed the forecast on the ECB deposit rate to 3.75% (from 3.25% previously). In addition, the bank expects the central bank to raise interest rates by 50 bps at meetings in March and May 2023. Deutsche Bank also assumes that in June, the ECB will decide on the final rise of the rate by 25 basis points. The ECB picked up the baton started by the American one and is ready to raise rates in case the economic situation changes.

The markets are focused on a possible review of the Fed's approach to rate hikes and a turn to increase the step of this hike (from 25 bps to 50 bps). Note that many Fed officials are ready to return to a 50 bps rate hike, but it is difficult to implement right now. However, in the near term, the Fed is not ruling out such a possibility. According to preliminary forecasts, a threefold increase in the key rate (three times 25 bps at each meeting of the Fed), to 5.25%-5.50%, is possible this year. Against this background, the U.S. currency has outperformed its competitors, primarily the euro, by strengthening its current growth.

At the moment, market sentiment has improved, despite clouds on the geopolitical horizon, as well as hawkish fears about further monetary policy of the Fed. The reason is the recent pullback in inflation expectations in the U.S. According to the St. Louis Fed, 10-year inflation expectations fell to 2.41% this week, falling back from their early December 2022 peaks. Earlier in the week, the index had renewed a two-month high. According to analysts, the first signals that inflation expectations are losing momentum could prompt the Fed to ease its monetary policy. This will put serious pressure on the USD, experts believe.

At the moment, the situation is good for the dollar: as long as the Fed rates are rising it gets a lot of support from that process. Take note that the recession will not hurt the greenback either: it will continue to grow and remain as the most convenient safe asset. The U.S. currency might fall if the Fed sharply cuts its key rate. However, this is unlikely because it would block all attempts by the central bank to curb inflation.