FX.co ★ EUR/USD: Although the ECB is opening the door for a stronger rate hike, the euro is not immune from further losses

Looking at how Europe is plunging into recession, the economy of China is slowing down sharply, and financial conditions in the United States are significantly tightening, investors rushed to seek refuge to hide from the whirlwind of bad news. They started buying dollars while selling risky assets at the same time.

As a result, the USD index has reached peak levels over the past 20 years just above 105.00 points.

Meanwhile, the euro set a new five-year anti-record around 1.0350, and the S&P 500 index was on the threshold of a bear market. Last Thursday, the indicator was trading at 3858.87, which is 19.9% lower than its intraday high of 4818.62 from January 4.

However, the S&P 500 showed a confident rebound on Friday, rising 2.4% to 4,023.89 points.

At the same time, the greenback slowed down after six consecutive weeks of growth, during which it reached its highest figures since December 2002.

The beginning of the week was marked by an ambiguous mood of the markets. Following the results of yesterday's session, the S&P 500 index sank by 0.39% to 4008.01 points. Nevertheless, the demand for risk prevailed during the day, which put pressure on the protective dollar.

On Monday, the US currency continued to retreat from 20-year peaks. It weakened moderately against its main competitors and closed for the second consecutive day in negative territory, about 104.15 points.

The EUR/USD pair took advantage of the dollar's weakness, demonstrating a rise of almost 0.4% to 1.0430.

There is a positive trend in global markets on Tuesday. The stock exchanges of the Asia-Pacific region closed with growth, European indices also noticeably increased. This trend was picked up by Wall Street indices.

A number of positive news supported risk appetite, while the greenback remained under pressure.

Shanghai has announced the absence of new cases of coronavirus infection in all areas, reviving optimism that lockdowns in China will be lifted by the end of the month.

Meanwhile, Eurostat reported that the eurozone's GDP, according to the second estimate, expanded by 5.1% in annual terms in the first quarter of 2022 and by 0.3% in quarterly terms.

Analysts expected the indicators to remain at the level of the first estimate: an increase of 5% year-on-year and 0.2% quarterly.

The EUR/USD pair maintained a bullish momentum on Tuesday, as the weakening of market volatility suspended the broad growth of the dollar.

"Risky assets are desperate for some stabilization after seven consecutive weeks of losses on US stocks and increased market concerns about a combination of the global economic downturn and tightening monetary policy," ING strategists said.

According to experts, the dollar's respite is due to the fact that many bad news have already been taken into account in quotes. In addition, investors have moderated expectations regarding an increase in interest rates in the United States.

Money markets are counting on a consistent increase in the federal funds rate by 50 basis points in June and July, as well as the fact that it will reach 2.75% by the end of the year.

At the same time, expectations are growing that other central banks will catch up.

European Central Bank Governing Council member Klaas Knot said on Tuesday that a 50 basis point rate hike should not be excluded from the agenda if incoming data in the next few months indicate that inflation is expanding and accumulating.

The hawkish comment by the head of the central bank of the Netherlands helped the euro rise above $1.05 for the first time since Thursday, dispelling fears that the single currency is on its way to inevitable parity with the dollar.

"The main question is what will happen after July and how quickly interest rates in the eurozone will go up," Societe Generale analysts said, noting that money markets now estimate an ECB rate hike of about 105 basis points by the end of the year against 95 on Monday.

Fed Chairman Jerome Powell will speak on Tuesday. If he once again confirms that the central bank will not raise the rate by 75 bps, then the correction of the US currency will continue.

Amid improving market sentiment, the USD index broke through support at 104.00 and dropped to 2-week lows in the area of 103.20.

In case of strengthening of the negative momentum, the index may aim for the 102.35 level (low on May 5), where, as expected, the fall may slow down.

The current bullish position in the index is still supported by a 3-month line around 100.00, while the long-term outlook for the dollar remains constructive as long as it is trading above the 200-day moving average, which is now passing near 96.40.

"We don't think we are in a market where we will see a weakening of the greenback. It will take a lot of effort to get investors to abandon the dollar," TD Securities strategists believe.

MIG Bank analysts agree with them.

"The dollar retreated after a very strong growth, it is basically stabilizing at a high level," they said.

According to experts, it is difficult to see a long-term shift in the fundamentals that strengthened the greenback amid concerns about global economic growth.

"The key factor is that the US economy is outperforming the rest of the world," they said, pointing to concerns about the eurozone and China in particular.

"Despite all the short-term obstacles, it is expected that the strength of the dollar will remain the driving force in 2022, as the Fed implements a new cycle of monetary policy tightening," MUFG Bank noted.

Strategists at Bank of America Global Research also maintain a bullish attitude towards the USD, expecting its further growth in the coming weeks.

"The topic of monetary policy divergence may be at the final stage, as evidenced by the muted reaction of US rates to the surprise from the April CPI data. However, the ECB and the Bank of Japan will "catch up" with the Fed only gradually and it is unlikely that this is enough to reverse the US currency," they said.

"High energy prices, which have kept the US dollar in good condition compared to major importers in Europe and Japan, are likely to persist at least until the fourth quarter – this is inextricably linked to the Ukrainian crisis and the possibility of EU sanctions on energy imports from Russia, which will put significant pressure on the euro"- analysts believe.

"Stocks are prone to an inevitable rally in a bear market, but we don't think the ultimate lows have been reached," they said.

Goldman Sachs analysts believe that further stock drawdown, growing risks of a global recession and high geopolitical uncertainty should support the dollar for now.

The pause in the sell-off of risky assets provided some temporary stability for EUR/USD, although it remains in a powerful downward trend.

Fears that escalating tensions with Russia could lead to a gas embargo, a recession in the eurozone and prevent the ECB from raising interest rates have recently clouded the prospects for the single currency.

"The risks to the European economy due to interruptions in energy supplies remain very high. Interruptions in Russian gas exports will stifle growth in Europe and cause a recession in the EU," said Joachim Lang, head of the Federation of German Industries (BDI).

According to the new forecasts of the European Commission, the recovery of the currency bloc's economy after the pandemic will almost stop, and price growth will accelerate if there are serious interruptions in natural gas supplies from Russia.

According to the EC's baseline forecast, the region's GDP will grow by only 2.7% this year, while inflation is expected at 6.1%.

"The conflict between Russia and Ukraine hinders the economic recovery of Europe. There may be other scenarios in which economic growth may be lower and inflation higher than we forecast today," Paolo Gentiloni, European Commissioner for Economics, said on Monday.

On Tuesday, the EUR/USD pair jumped by more than 100 points from the last closing level of 1.0430.

The single currency was helped by the positive tone of global stocks, as well as comments by ECB Governing Council member Klaas Knot.

There will be no shortage of hawkish comments from the ECB, say Commerzbank economists, who believe that the EUR/USD pair may sink even lower ahead of the July meeting of the ECB.

"If we really see a rate hike, the euro can win. Until then, it probably matters to what extent the ECB will be able to convince the markets of its intentions," the experts said.

"There will be no shortage of hawkish comments from the ECB. The closer the July meeting of the central bank is, the more the euro can benefit from this. However, this does not mean that we will not see even lower levels for EUR/USD until then. After all, July is still a long way off," they added.

The main currency pair remains bullish, although further growth has not yet been confirmed.

The next significant obstacle occurs at the weekly high of May 5 at 1.0640 before the 55-day moving average, which is currently around 1.0820.

However, as long as the pair remains below the 3-month line around 1.0880, it will be vulnerable to additional losses. The initial support is located at 1.0510, followed by 1.0470 and 1.0430.