10.05.202208:48 Forex Analysis & Reviews: EUR/USD: dollar is trying to slow down, and the euro is imagining stagflation

The rapid growth of the US currency puzzled the markets. Analysts and traders are wondering: how long will the USD rise last? Many note that the latter is gradually losing ground. Against this background, the euro is trying to score points and catch up.

Experts pay attention to the growth of the greenback and the simultaneous subsidence of the euro, fearing a significant imbalance in the EUR/USD pair. To date, the pair maintains a balance, but it is quite fragile. At the same time, the European currency is gradually regaining its place under the financial sun. On the morning of Tuesday, May 10, the EUR/USD pair cruised near 1.0567, winning back previous losses.

According to experts, the greenback is benefiting from capital flows to safe haven assets and rising US government bond yields. This allows the EUR/USD pair to stay above 1.0500, heading towards 1.0600. However, in the coming days, the pair will remain under bearish pressure if the market sentiment is pessimistic.

Against the background of the aggravation of the Russian-Ukrainian conflict and the growing risks of stagflation and recession, market participants expect that the euro will reach parity with the dollar. Geopolitical tensions and a crisis in supply chains are increasing the risk of stagflation, "which could lead to euro parity against the dollar for the first time in 20 years," Bloomberg estimates. Most of the respondents polled by the agency believe that the EUR will equal the USD. There are more supporters of such a decision among Europeans than among Americans. At the same time, many traders expect the euro to recover to 1.1500 in the medium term.

Currently, the EUR/USD pair is approaching the lows of 2016. Later, the pair went to 1.0500 and above. According to analysts, a long-term correction of the EUR/USD pair will take it to the 1.0700-1.0760 levels, where strong Fibonacci levels are. This is facilitated by the hawkish mood of the European Central Bank, which announced its readiness to increase rates in July 2022.

Against this backdrop, the US currency continues to strengthen its positions, despite short-term failures. The dollar is strongly supported by two factors - the Federal Reserve's rate hike by 50 bp and USD's status as a safe haven asset. According to analysts, at the moment the central bank has chosen the so-called "soft option for tightening monetary policy." Its meaning is that the interest rate has been increased, but not too much (by 50 bp, and not by 75 bp, as some expected), and the sale of assets on the balance sheet has also been launched, but not immediately for $95 billion monthly and three months later. Currently, the volume of assets sold by the Fed does not exceed $47.5 billion monthly. Experts consider this decision expedient.

The process of tightening monetary policy, launched by the Fed, increases the greenback's appeal. However, further growth of the USD is in doubt, as its unrestrained upward movement creates obstacles for medium-term strengthening. According to experts, in the last month the dollar index (USDX) has risen too sharply, bypassing the correction. The market does not forgive this, so the greenback will have to work out such movements.

The complexities accompanying the dynamics of the dollar are reflected in the actions of the Fed. The central bank is now caught between the hammer of inflation and the anvil of recession. Recall that skyrocketing inflation requires tougher monetary policy, but at the same time, the risk of a recession increases. However, the Fed had to agree to such a scenario in order to prevent another round of inflation. According to analysts, a recession in the US is possible against the backdrop of rising energy prices, disruption of supply chains and reduced consumer demand.

The ECB found itself in a similar situation, which is alarming not only about a potential recession, but also about the threat of stagflation in the eurozone. According to Olli Rehn, Governor of the Bank of Finland and a spokesman for the ECB Governing Council, stagflationary trends are clearly visible at the moment. The politician focuses on the extremely difficult economic situation in the eurozone, which is threatened by recession and stagflation.

According to Rehn, this is "a choice between plague and cholera." The head of the Bank of Finland announced the need to "prevent the strengthening of inflationary expectations." To do this, the key rate should be raised in the third quarter of 2022, namely in July. Earlier, ECB representatives, Philip Lane and Fabio Panetta, announced the readiness of the central bank to increase rates in the second month of summer. The reason is the skyrocketing inflation in the eurozone at 7.5%. It is expected that this measure will help normalize the monetary policy, provided that the Russian-Ukrainian conflict does not throw the European economy to the bottom.

Currency strategists at Bloomberg note that the geopolitical factor and Europe's dependence on cross-border trade are worrying investors. However, many market participants consider the risks of stagflation and recession more relevant than further inflation growth. The real danger comes from the first two processes that can radically change the current situation in the economy.