The greenback was licking its wounds on Wednesday after suffering a crushing defeat on Tuesday.
According to the results of Tuesday's trading, the dollar fell in price against its main competitors by almost 1.4%, demonstrating the strongest drop in more than two years.
The protective dollar came under selling pressure amid hopes that leading central banks may switch to a less aggressive monetary policy in the near future.
On Monday, the Bank of England confirmed its readiness to buy bonds with a long-term maturity.
Last week, BoE announced that it would start buying government bonds instead of the planned sale amid a sharp increase in their profitability.
"The purpose of such purchases is to return to normal market conditions. Purchases will be made on any scale necessary to achieve this goal," the central bank said.
At the same time, the central bank clarified that purchases of government bonds are a temporary phenomenon, and it firmly intends to continue raising the rate to combat historically very high inflation and return to sales of government securities from its balance sheet.
However, market participants regarded the BoE's actions as a softening of the central bank's position.
It is obvious that it will be extremely difficult for the BoE to withdraw liquidity and reduce the balance sheet due to the stressful state of the financial sector and the deterioration of the economic prospects of Great Britain.
It is assumed that in the future the BoE will be forced to focus on raising the key rate, and at a more restrained pace, along with periodic purchases of government bonds to stabilize "long" rates.
On Tuesday, the Reserve Bank of Australia was already in the focus of attention, which surprised investors with a smaller-than-expected increase in the key interest rate.
The central bank raised the cost of borrowing by 25 basis points, while the vast majority of economists expected it to increase by 50 bps.
The Reserve Bank of Australia explained its decision by the deterioration of the global economic outlook.
This raised hopes that the Federal Reserve could also slow down the pace of rate hikes, which in turn spurred dollar sales and helped restore demand for risky assets.
Over the past two days, the USD has sunk by about 1.8%, losing about half of the growth in September. At the same time, the S&P 500 index rose by almost 6%.
The rally of risky assets at the beginning of the week was caused by a variety of factors, including oversold stocks and easing market tensions in Europe, Deutsche Bank strategists said. However, the main driver was expectations that leading central banks may soon return to dovish stances, especially after the turmoil in global markets that took place in the last couple of weeks, they added.
In particular, there are hopes that the peak of the tightening cycle in America is just around the corner.
A series of weak data on the United States only fueled these hopes.
Thus, the Institute for Supply Management (ISM) reported on Monday that the PMI index in the US manufacturing sector fell to 50.9 points in September from 52.8 points a month earlier. Analysts on average expected the indicator to decrease to 52.2 points.
A separate report, which was published on Tuesday, reflected a sharp decline in the number of open vacancies in the country in August. The indicator fell at the fastest pace since the beginning of the pandemic in 2020 – by 10%, to 10.1 million vacancies.
According to a number of experts, some cooling of the labor market will contribute to the weakening of inflation in the United States and may reduce the need for further sharp tightening of monetary policy by the Fed.
"If this trend continues, the Fed may back off somewhat in terms of the pace of rate hikes at the end of this and the beginning of next year," Natixis Investment Managers said.
A similar point of view is held by the economists of Pantheon Macroeconomics.
"The first clear sign of weakening demand for labor will force the Fed to do less. If this trend continues over the next few months and core inflation falls as much as we expect, the US central bank will not raise the rate by 125 bps by the end of the year. Our base scenario is 100 bps, but now we cannot exclude 75 bps or even 50 bps," they said.
Weak statistical data on the US economy served as a signal for an increase in risk appetite, as they indicated in favor of reducing the trajectory of the Fed rate hike.
A sharp reduction in the number of vacancies allowed investors to assume that the Fed will move from raising rates by 75 bps to a step of 50 bps in early November.
Armed with this idea, the key Wall Street indexes ended trading on Tuesday with active growth. In particular, the S&P 500 rose by 3.06%, reaching 3,790.93 points.
The rally in the US stock market has started several times this year in the hope of a change in the Fed's course. But then the indices turned around and rolled back to new lows.
Many market observers view the current stock rebound with a certain degree of skepticism.
Strategists at UBS Global Wealth Management explain it as oversold, reinforced by the revision of investment portfolios.
Natixis Investment Managers Solutions believes that the rebound was facilitated by the actions of bearish investors who closed their positions after the deep September falls.
BofA Global Research analysts note that there are practically no signs of capitulation among retail traders, which would indicate that the market has reached the "bottom".
In addition, the so-called "Wall Street Fear Index" has not yet risen to levels that indicate the passage of turning points during past sales.
The first important technical signal will be the consolidation of the S&P 500 above 3900 points (the Fibonacci correction level by 61.8%). The bulls' next targets will be 4000 (50-day moving average) and 4200 (200-day moving average).
Only a confident breakthrough of these levels will indicate that we are seeing a fundamental change in market sentiment, and not another rally in the bear market.
Investor optimism, which led to a sharp decline in the dollar, seems to have weakened somewhat on Wednesday. As a result, the shares reduced their recent growth, and the greenback managed to regain composure, finding support just below 110 points and rising by about 1% during the day.
"Investors were overly optimistic about the slowdown in the Fed's rate hikes, given its stated focus on fighting inflation," ING analysts noted.
"The domestic situation in the US remains fairly stable, leaving the prospects for tightening the Fed's policy in force, even if the markets recently revised the expected final rate to below 4.50%," they added.
On Wednesday, ADP reported that the number of jobs in the US private sector in September increased slightly more than forecast – by 208,000. Meanwhile, the ISM index of business activity in the country's services sector fell less than expected last month – to 59.1 points against 60.9 points in August.
"Weaker-than-expected data on job openings in the US, combined with a smaller-than-expected rate hike by the Reserve Bank of Australia, caused a wave of speculation that the Fed may also be ready to reduce the pace of rate hikes. But we think it's too early to talk about a reversal of the Fed's policy. Therefore, we remain bulls for the US dollar and maintain our target for the EUR/USD pair at 0.9500 in the future for 1-3 months," Rabobank strategists said.
The main currency pair showed impressive growth on Tuesday and tested parity. However, on Wednesday it turned down.
The greenback came to the fore again after the Reserve Bank of New Zealand raised the rate by 50 basis points for the fifth consecutive time.
"The RBNZ's hawkish signals reminded market participants that the fight against inflation is still a priority for many central banks," Maybank analysts said.
Amid renewed demand for a protective dollar, the EUR/USD pair fell by more than 140 points from the previous closing level of 0.9983, before regaining some losses.
Disappointing data on the eurozone reinforced the weakness of the single currency.
The final composite purchasing managers' index from S&P Global for the eurozone, which is considered a good indicator of economic health, fell to a 20-month low of 48.1 points in September from 48.9 points in August. The indicator was below the preliminary estimate of 48.2 points.
"Any hopes that the eurozone will avoid recession are further dashed by the sharp drop in business activity signaled by the business activity index," S&P Global analysts noted.
"The rapid rise in inflation associated with the energy crisis and the military conflict in Ukraine is destroying demand, while business confidence is falling to levels not seen since the debt crisis in the region in 2012, excluding quarantine due to the pandemic. Both companies and households are cutting costs and investments in preparation for the harsh winter," they added.
The recent growth of the EUR/USD pair was caused by the weakening of the dollar after a disappointing purchasing managers' index for the US manufacturing sector and a significant reduction in the number of vacancies in August, analysts at Commerzbank say.
"We believe that the market is somewhat more optimistic that the eurozone will survive the energy crisis this winter more smoothly than many feared earlier. It remains extremely uncertain to what extent the current energy crisis will continue to put pressure on the economy of the eurozone in the long term, which, in our opinion, will justify an increased risk premium at the euro exchange rate for quite a long time," they said.
Credit Suisse strategists believe that the EUR/USD pair remains in a downward trend, and the financial difficulties faced by the eurozone mean that the "bottom" has not yet been reached. They prefer to sell the pair on a rally to 1.0000.
The EUR/USD pair is likely to weaken over the next 1-3 months, potentially testing support around 0.9000 before settling around 0.9300-0.9400, according to Standard Chartered.
"While gas reserves in Europe have reached almost 85% of maximum capacity, energy security and energy savings issues, along with the relatively slow pace of ECB rate hikes, are likely to put downward pressure on the euro in the near term. On a 12-month horizon, we expect that a reduction in the difference in interest rates between the United States and Europe will push the single currency to growth," the bank's analysts said.
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