14.05.202400:49 Forex Analysis & Reviews: The dollar is in trouble

Rumors about the US imposing additional tariffs on imports from China temporarily stopped the EUR/USD bulls from attacking. The trade wars create a tailwind for the US dollar as a safe-haven currency. However, recognizing the fact that the divergence in economic growth between the US and the Eurozone is getting smaller has made it possible for the bulls to regain the initiative.

Recent reports on the American economy have been increasingly disappointing. This has led to a decrease in the economic surprise index, treasury bond yields, and weakened the US dollar's position. Now investors eagerly await inflation data to understand whether the USD index will fall further.

Dynamics of the economic surprise index and US bond yields

The story is different in the Eurozone. The recent reports have been pleasant. The positive trend allows Bloomberg experts to raise the GDP growth forecast for the bloc from 0.5% to 0.7% in 2024. The estimate for the German economy has also increased—from +0.1% to +0.2%. Thus, the divergence in economic growth is not as huge as previously thought, enabling hedge funds and asset managers to switch from selling EUR/USD to buying.

The US economic reports have been deteriorating, causing the US dollar to lose its main advantage of American exceptionalism. However, this is not the only problem. Several divergences exist in 2024: in GDP growth, in monetary and trade policies. This creates ideal conditions for playing on the difference. Moreover, the effectiveness of carry trade involving the US dollar since the beginning of the year is the highest since the first half of 2010.

Dynamics of the effectiveness of carry trade involving the US dollar

Investors are counting on the Federal Reserve to keep the federal funds rate at its peak longer than previously expected. Meanwhile, the weakness of funding currencies such as the yen, franc, and Swedish krona creates excellent opportunities for carry trade.

As the US economy cools, the situation will change. If US inflation slows in April, as Bloomberg experts predict, Treasury bond yields will fall, and this will decrease the effectiveness of carry trade involving the dollar. Positions will be closed to transfer money into other high-yielding currencies, accelerating the decline of the USD index.

Regarding Washington's increase in tariffs on Chinese imports, without a symmetrical response from Beijing, it is unlikely that we can talk about the resumption of trade wars. China has already found alternative routes to sell its goods and will not seek trouble. This is a very bad scenario for the EUR/USD bears.

Technically, a 1-2-3 reversal pattern has appeared on the daily EUR/USD chart. However, the fact that bulls can't play it out by reducing quotes to point 2 indicates their weakness. Therefore, if the euro climbs above $1.0795, this would seem like a good opportunity to increase previously established long positions with a target of $1.108.