The greenback began the week on a weak note. On Monday, the dollar fell by about 0.5%. During the start of the European session on Tuesday, it dipped to monthly lows around 105.30. However, later, it recouped its early losses and ended the trading session with a rise of almost 0.7% to around 106.20.
On Wednesday, the USD increased by nearly 0.3%, reaching 106.50. On Thursday, the greenback maintained its leading position in the market and traded near two-week highs above 106.80.
The dollar's rally was supported by PMI data showing that the US economy remains stable, unlike the eurozone and the UK. The rising yields of long-term treasuries and declining key Wall Street indicators also boosted the US dollar.
On Wednesday, the S&P 500 index dropped by 1.4% to 4,186.77 points, marking its largest daily decline since the end of September. This was the first time since May that the index closed below the 4,200 threshold.
There are plenty of concerns in the market, from Congress's inability to extend the federal government's operations on November 17th to weak corporate earnings and a new sell-off of US government bonds. The yield on 10-year treasuries increased by about 12 basis points to 4.95%.
Strategists from RBC Capital Markets reported that the yield on ten-year treasuries was returning to test the 5% level. The negative correlation between bonds and stocks remains relevant. Thus, there is no surprise that the dollar remains the leader.
A new surge in oil prices also supported the dollar. Yesterday, oil prices advanced by 2% due to concerns about escalating conflicts in the Middle East and reduced raw material supplies from the region.
Israeli Prime Minister Benjamin Netanyahu announced on Wednesday that the country would not rule out a ground operation in Gaza.
Specialists at SIA Wealth Management Global said that geopolitical factors, such as the conflict in the Middle East, were still the main driver of the oil market.
At the current oil price above $75–80 per barrel, there is significant bullish interest. Unless something significant impacts supply and demand or political events occur, the upward trend in the oil market will continue.
The timeline for an Israeli army invasion of Gaza has not been announced. However, under such a scenario, there is an increased risk that Iran could become a more active player in the region. This could potentially lead not only to oil supply disruptions but also to the expansion of the Middle Eastern conflict.
All of this is happening just as the Federal Reserve is trying to balance the threat of a new jump in inflation with the risk of putting undue pressure on the economy. Last week, Federal Reserve Chairman Jerome Powell highlighted the conflict between Israel and Hamas as one of the risks to consider.
Given the uncertainty and risks, and considering how far the Fed has come, the FOMC is proceeding with caution. The Fed is likely to make decisions about the extent of further policy tightening and how long the policy will remain restrictive based on the full range of incoming data, evolving outlooks, and risk assessments.
The European Central Bank (ECB) is also closely monitoring the ballooning crisis in the Middle East and its potential impact on the eurozone economy. ECB President Christine Lagarde stated this on Wednesday. "It is a region of the world where there is a lot of traffic of oil tankers, where there are oil producing countries as well and where there could be an impact either directly or indirectly or through the confidence channel, which also matters," she remarked.
For the ECB, the situation is aggravated by the events in the Middle East, signaling a period of high inflation and growth stagnation for the eurozone.
On Thursday, the European regulator will announce its monetary policy decision. It is anticipated that interest rates will remain unchanged, halting a 15-month period of hikes. The most challenging part for the ECB will be signaling its future intentions.
Some policymakers favor a hawkish pause or guidance that retains the option of further rate hikes, especially given that inflation is not expected to return to the ECB's 2% target until 2025. The escalating situation in the Middle East might put upward pressure on energy prices. Other officials argue that growth prospects in the eurozone are deteriorating so quickly that a neutral stance, emphasizing dependence on data, would be better.
Ahead of the ECB's announcement, the euro hit a weekly low against the US dollar, around $1.0540.
Economists at TD Securities discussed the upcoming ECB decision and its implications for the EUR/USD pair. They presented three scenarios:
Hawkish scenario (25% probability):
The ECB maintains the status quo in line with market expectations. However, statements will become more hawkish. Specifically, the regulator will highlight that geopolitical instability could be grounds for further rate hikes if a subsequent inflationary shock is strong enough to solidify inflation expectations. Under this scenario, the EUR/USD pair would increase by 0.45%.
Base scenario (65% probability):
The ECB will leave the key rate unchanged, as expected. While the regulator will not close the door on further rate hikes, it will essentially hint that such a move is highly unlikely. Under this scenario, the EUR/USD pair would decrease by 0.1%.
Dovish scenario (10% probability):
The ECB will maintain the current rate as anticipated but will clearly state that the monetary policy tightening cycle is likely over. Under this scenario, the EUR/USD pair will drop by 0.3%.
The level of 1.0530 acts as initial support. If the European Central Bank (ECB) takes a dovish stance, the targets for sellers could be seen at 1.0500 and 1.0470.
On the other hand, the closest resistance is at 1.0550. If the ECB delivers hawkish comments, levels of 1.0600 and 1.0650 might come into play.
The strengthening of the dollar caused the pound sterling to fall to a three-week low of around $1.2070 on Thursday.
October was the worst month ever for UK retailers in terms of sales volume. They expect another challenging month in November as households grapple with rising living costs, according to a survey released today by the Confederation of British Industry (CBI).
Data released on Tuesday indicated a weakening UK labor market. Meanwhile, the UK's preliminary PMI data for the services sector from S&P Global dropped to its lowest level since January.
These reports reinforced the market's belief that the Bank of England will likely maintain its current interest rates at its policy meeting next week.
If the BOE says that it is still far from combating high inflation in the UK, despite growing recession fears, this could limit any pound selloff.
James Smith, an economist with ING, said the BoE - like other central banks - will want to ram home its message that it will not be cutting rates any time soon, despite the growing signs that the economy is flat-lining.
However, analysts do not anticipate a significant impact on the pound/dollar pair from the upcoming meeting. They predict a cautious tone combined with limited statements about the regulator's plans.
ING believes that dollar dynamics and geopolitical events might play a more crucial role in shaping the short-term GBP/USD trend.
The sterling has been declining against the dollar for three consecutive days.
The Relative Strength Index (RSI) remains above 30, indicating room for the GBP/USD pair to decrease.
The 1.2050 level serves as immediate support. A close below this level could lead to a decline to 1.2000 and 1.1950.
Meanwhile, the initial resistance is located at 1.2100, followed by 1.2140 and 1.2180.
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