The next meeting of the Federal Reserve will take place in two weeks, but investors continue to wonder what the central bank's next steps will be.
On Saturday, St. Louis Fed President James Bullard said the latest U.S. CPI data showed that inflation had become "disastrous" and left room for a 75 basis point rate hike at the upcoming Fed meetings in November and December, but noted that it is too early to draw such conclusions.
The Fed's rapid interest rate hikes have helped strengthen the dollar against other currencies, but that support could wane once the central bank hits the rate hike stop point, Bullard added.
Of late, stock market players have been frantically looking for reasons why the Fed can halt policy tightening, clinging to every data point in the hope of seeing a much-desired reversal.
At the same time, positive statistics for the US causes a negative reaction from market participants and vice versa.
The fact is that monetary policy can affect inflation by managing consumer demand, and as the Fed is now trying to slow down economic activity, positive statistics are forcing the central bank to raise rates harder or longer.
On Friday, key Wall Street indicators opened higher after the US Department of Commerce said retail sales in the country were unchanged in September from the previous month. Analysts on average had expected a 0.2% increase last month.
Stocks reversed course after results from the University of Michigan monthly survey showed US consumer sentiment improved in October. The indicator rose to 59.8 points from 58.6 points recorded in September.
In addition, according to the survey, medium-term inflation expectations among Americans rose to 5.1% in October compared to 4.7% in the previous month. Inflation expectations for the long term (5 years) increased to 2.9% from 2.7%.
Data published last Thursday indicated that consumer prices in the United States in September increased by 8.2% year-on-year, compared with 8.3% in August. Looking at these data, some investors felt that the worst of the inflationary shocks to the American economy had already passed.
"However, the fact that we observed a peak in inflation has not yet been confirmed, and this depresses the market," Ameriprise Financial analysts said.
Trading on the US stock market on Friday, after attempts to grow at the beginning of the session, ended with a decline in three major indices. In particular, the value of the S&P 500 for the day fell by 2.37%, amounting to 3583.07 points.
Tracking the decline in key Wall Street indicators, the greenback showed a 0.5% rise and ended the week near 113.20 points.
Against the background of the strengthening of the dollar, the EUR/USD pair sank by 0.6%, finishing around 0.9720.
At the start of the new week, the greenback was under selling pressure and returned to the levels of 11 days ago, losing about 1% and testing the strength of support at the level of 112.00.
Positive news received from Great Britain over the weekend reduced the demand for the dollar as a protective asset.
So, the new British Finance Minister Jeremy Hunt announced that he was canceling "almost all" tax measures proposed by Prime Minister Liz Truss and his predecessor Kwasi Kwarteng just three weeks ago.
Although this is primarily good news for the pound, other major currencies have also benefited.
The main US stock indexes also rose markedly on Monday amid an overall positive trend. So, the S&P 500 gained about 2.5%.
However, some experts warn that political uncertainty in the UK has not disappeared, but rather intensified. This is good news in the short term, but it is difficult to talk about the long-term impact, they note.
In particular, Saxo Bank strategists point out that the financial problems of Great Britain will remain in the spotlight.
"We still don't have anything that can solve Britain's structural problems, but there is a huge gaping double deficit that still needs funding," they said.
A number of analysts foresee a further pullback in the US stock market in anticipation of another large-scale increase in the Fed's interest rate.
According to them, while the central bank is focused on inflation, investors should hardly bet that officials of the US central bank will take measures aimed at supporting the stock market if it starts to fall sharply and quickly to alarming levels.
In the current situation, priority is given to the fight against inflation, which has become the number one problem, and the market will suffer as a side effect.
At the same time, many economists doubt the ability of the Fed to continue raising rates to slow inflation without causing an increase in unemployment and recession.
About 59% of experts surveyed recently by The Wall Street Journal fear that the Fed will raise rates too high.
"The "soft landing" is likely to remain a fairy tale that will never become a reality," representatives of the University of Michigan said.
"The negative impact from rising rates and a strengthening dollar is huge, and it will cost about 2.5% of US GDP growth next year. In light of this, it is hard to imagine that the country can avoid a recession," Jefferies strategists said.
The vast majority of American company executives expect a recession in the next 12-18 months, according to a survey by the Conference Board research company.
About 98% of the chief executive officers of companies located in the United States are preparing for an economic downturn.
Among the heads of European companies, the share of pessimistic managers is even higher - 99%. Only 5% believe that the situation in the economy will improve in the next six months.
"Company executives are preparing for an almost inevitable recession in the United States and Europe. Most believe that the recession in the United States will be short and moderate, but about 70% of respondents believe that the European Union is in for a deep recession that will have serious consequences for the whole world," said Roger Ferguson, a member of the Conference Board leadership.
The dollar is the beneficiary of such concerns and the potential continuation of the Fed's rate hike.
"The hawkish reassessment of expectations for a Fed rate hike and growing concerns about a "hard landing" of the global economy support our forecast for an even greater strengthening of the dollar," MUFG Bank analysts said.
"The latest reports on NFP and CPI in the US have pushed back expectations of a dovish reversal of Fed policy. Now we are more confident that the central bank will continue to raise rates at a faster pace until the end of this year. Based on our current forecasts for the end of the year, we see opportunities for USD growth by about 5%," they added.
ING also remains positive on the US currency as the Fed is determined to raise rates.
"The message remains that the Fed will seek to raise rates for a longer time to combat the biggest inflationary threat since the early 1980s, and the dollar will continue to get good support in downturns," they said.
"The Fed's determination to raise interest rates, coupled with geopolitical and energy concerns, should keep markets' risk sentiment under pressure. Therefore, a USD break above the September high at 114.70 is only a matter of time," ING believes.
Bank analysts are skeptical about the current EUR/USD rally and believe that the pair will resume its downward trend.
"We continue to believe EUR/USD will test September lows in the 0.9540 area in the near term and fall below that level by the end of the year," they said.
With the safe dollar losing ground across the board, the EUR/USD pair has overcome the weakness seen late last week.
On Monday, it rebounded about 130 points from the previous close.
However, the eurozone economy faces major challenges as inflation is at historical levels due to rising energy prices and the Ukraine conflict is far from resolved, which is likely to hamper a sustainable euro recovery.
Initial resistance for EUR/USD lies at 0.9850, a breakthrough above which could lift the pair to 0.9900. Subsequent buying will pave the way for additional gains, although any significant upward momentum is likely to remain limited near parity. If this mark is still broken, it will mean that the pair has formed a short-term "bottom".
On the downside, 0.9700 acts as immediate support ahead of last week's low at 0.9630. Next comes the 0.9600 mark, in case of a breakthrough below which EUR/USD may become vulnerable to retesting the lows of 20 years ago, recorded last month in the 0.9540 area.
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