Last week, risk assets led by US equities and the euro still managed to tip the scales in their favor as traders reduced their expectations of where US interest rates could peak.
The S&P 500 added more than 6% over the past five days, while the USD index lost about 0.5%.
Wall Street's key indices finished up the first week out of four.
At the same time, the greenback posted its first weekly decline this month.
While investors have also moderated their expectations of a potential European Central Bank rate hike, the euro has benefited from a rebound in stock indices that has undermined demand for safe-haven assets like the US currency.
This was largely fueled by hopes that falling commodity prices would help lower headline inflation, especially during the fall months, lessening the need for aggressive monetary tightening in the US.
In addition, market participants drew attention to the statements of Federal Reserve Chairman Jerome Powell, who pointed out that it would be difficult for the central bank to reduce inflation without harming the labor market and the economy as a whole.
Investors interpreted Powell's recognition of the risk of a recession as a signal that monetary tightening beyond what was already included in stock quotes and the dollar after the June FOMC meeting was not required.
Money markets expect the federal funds rate to peak next March at around 3.5% and fall nearly 20 basis points by July 2023.
US data released on Friday reinforced traders' belief that the Fed may not have to tighten policy as seriously as expected.
The US Consumer Confidence Index, calculated by the University of Michigan, fell to a record low of 50 in June from 58.4 a month earlier, final data showed.
In addition, the University of Michigan revised down the dynamics of inflation expectations of Americans: in the medium term (next year) - up to 5.3% from 5.4%, in the long term (5 years) - up to 3.1% from 3.3 %.
Signals of deteriorating economic activity and signs of easing inflationary pressures in the US provoked a weakening dollar and allowed Wall Street's key indices to make a full-fledged rally. The S&P 500 jumped 3.06% to 3911.74. The indicator showed the largest percentage rise since May 2020.
At the same time, the euro showed more modest gains compared to US stocks.
The EUR/USD pair added almost 0.3% on Friday, and at the end of the week it gained only 50 points, finishing in the 1.0554 area.
Meanwhile, the USD index failed to reach the level of 105.00, ending last week with moderate losses, which, according to experts, look quite appropriate after three weeks of continuous growth.
The continued positive mood in the markets helps the single currency find demand at the beginning of the new week, while the protective dollar remains under pressure.
Investors continue to overestimate the prospects for tightening the policies of the leading central banks, ignoring the risks of a global recession.
Portfolio rebalancing at the end of the quarter and half of the year could help stocks and soften the dollar this week, ING specialists say.
After a powerful stock rebound last week, some traders started talking about reaching the "bottom". However, the current dynamics are still within the correction framework, and downside risks remain.
The S&P 500 may rise another 5-7% before resuming losses, Morgan Stanley analysts say.
The bank's base case for a "soft landing" for the US economy sees the S&P 500 bottom between 3,400 and 3,500, 13% below its last close. And a recession would send the index down more than 23% to around 3,000 points.
Goldman Sachs analysts believe that concerns about inflation and high commodity prices are likely to make the second half of the year as volatile as the first.
"There is a downside risk in the stock markets. In such an environment, as you know, the dollar is king," they said.
"We doubt that the greenback will fall much. It is too early for central banks to signal that everything is clear with inflation. And signs that central banks will continue to tighten measures in the second half of the summer, even despite the slowdown in growth, may provoke a new wave of stock sales," ING said.
The specter of a global slowdown and the preference for dollar-denominated assets in such times should prevent a further fall in the US currency, according to Commonwealth Bank of Australia strategists.
"The dollar tends to rise when people are worried about a global recession," they said.
Analysts of Capital Economics hold a similar opinion.
According to them, the situation in the global economy will remain favorable for the greenback in the foreseeable future.
The growth of the American economy will slow down, but a recession will be avoided, and the United States is quite well prepared to cope with the tightening of monetary policy, experts say. However, even if the situation develops according to an unfavorable scenario, the dollar will continue to win as a safe haven currency, they predict.
Bloomberg expects a recession in the US within 12-18 months. Reuters estimates the chances of such an outcome at 40% in the future of two years and at 25% on the horizon of the year.
The risks of an economic downturn for the eurozone are even higher than in the United States, given that the consequences of rising interest rates in the region are more significant due to the heterogeneous composition of the countries of the currency bloc.
The ECB, like its American counterpart, aims to curb inflation. Since July 1, the ECB has been curtailing the bond repurchase program, promises to raise the key rate by 0.25% for the first time since 2014 at the next meeting and is ready to continue in the same spirit, despite the obvious difficulties in the economy and the energy crisis in the eurozone.
"Ultimately, it seems more likely that the Fed will pause until the end of the year, but a specific energy shock due to a sharp rise in natural gas prices may occur earlier and may become a catalyst for a new decline in the EUR/USD pair," MUFG Bank analysts said.
On Monday, the main currency pair is once again testing the 50-day moving average at 1.0600.
The pair's repeated failures near this mark make traders cautious before opening long positions.
"The current price movement corresponds to our baseline scenario, according to which the EUR/USD pair will trade in the range during the summer months before making a moderate increase at the end of the year, if, as we believe, the market shifts towards pricing due to the start of the Fed policy easing cycle at the end of 2023. Currently, however, the US central bank continues to sound a hawkish refrain, and the EUR/USD pair may struggle to keep growth above the 1.0625-1.0640 area this week," ING said.
The main currency pair should make a confident breakthrough of the former 1.0650 support, which has now turned into resistance, before returning to the 1.0700 mark. The next significant obstacle is in the area of 1.0745-1.0750, and further – in the area of 1.0780-1.0785.
On the other hand, support in the 1.0535-1.0530 zone should limit the fall, its breakdown will bring into play the psychologically important 1.0500 mark, followed by support in the 1.0480 area. Subsequent shorts will make the pair vulnerable.
"The inability of EUR/USD to protect the 1.0340 level will confirm the continuation of the decline. The next potential targets may be at the level of 1.0070-1.0000 (76.4% correction of the entire upward trend during 2000 and 2008)," Societe Generale strategists noted.
"The neckline at 1.0790-1.0810, which is also the March low, is an important resistance. Until this line is crossed, the downward trend is expected to continue," they added.
As the policy of the leading central banks, which prioritize the fight against inflation, tightens, concerns about the economic downturn on both sides of the Atlantic and the associated negative sentiment in the markets may increase.
These factors together will put pressure on stock quotes and the EUR/USD exchange rate.
"The continuing recession risks are likely to put pressure on the euro for longer than previously assumed in our central scenario. As a result, we postponed the EUR recovery," Commerzbank analysts said.
"If the Fed lowers the key rate again in 2023, and the ECB does not, the advantage of the US dollar in terms of the real interest rate will disappear, which means that the main reason for its strengthening, which we have been observing for more than a year, will disappear. Therefore, we now expect a significant weakening of the greenback in 2023, and not in 2022. We still left our target for EUR/USD at 1.1600, but we expect that it will take much longer for the pair to reach this target," they said.
Societe Generale analysts expect that the upward trend in USD will continue, so the US currency may rise to 111.
"In the short term, we do not rule out a consolidation phase around 101.30-101.00 and 106. Ultimately, a move above 106 will lead to the next turn of the upward trend. We expect the USD index to gradually rise to the next levels at 109 and the top point of the multi-year channel around 111-112," they said.
"Only a break below 101 will mean the risk of deepening the correction. If this breakthrough occurs, the next potential support levels will be in the 99.40 area and near the 200-day moving average at 97.50," Societe Generale noted.
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