16.05.202213:39 Forex Analysis & Reviews: EUR/USD: is it still far from parity?

The new trading week did start so well for the dollar. Futures for the dollar index (DXY) are declining at the beginning of today's European session, preceding a flat during the Asian session. At the time of writing this article, they are trading near 104.47, continuing their decline for the second trading day in a row after hitting a new high since January 2003 at 105.06 on Friday.

Nevertheless, it is still too early to talk about the weakening of the dollar. The DXY index has been falling so far only due to the strengthening euro (its share in the DXY is approximately 57.6%). As of this writing, EUR/USD is trading near 1.0432, 25 pips above today's opening price.

However, the decline of the dollar began last Friday. Perhaps it was the fixation of some of the many long dollar positions at the end of the week, or perhaps investors were alarmed by macro statistics received last week from the US, showing inflation indicators with values weaker than expected.

Thus, the consumer price index (CPI) in April rose by +0.3% (+8.3% in annual terms), exceeding the growth forecast by +0.2% and +8.1%, respectively. Although growth was better than expected, it still slowed down from +1.2% and +8.5%, respectively, in March. According to another Bureau of Labor Statistics report, also released last week, the Producer Price Index (PPI) fell from 11.5% to 11.0% in April (in annual terms). The core producer price index (Core PPI) fell from 9.6% to 8.8% in April (in annual terms). The data turned out to be worse than market expectations (10.7% and 8.9%, respectively), but still lower than the previous month.

The data suggests that the Fed's more aggressive policy so far is producing positive results. Inflation in the US continues to rise, but at a slower pace.

Federal Reserve Chairman Jerome Powell recently reaffirmed that the central bank's main task is to regain control of inflation. If the economic performance is in line with expectations, then he considers it appropriate to raise interest rates by 50 basis points at the next two meetings. However, Powell also brought some intrigue and gave market participants food for thought by saying that "if things come in better than we expect, then we're prepared to do less. If they come in worse than when we expect, then we're prepared to do more."

At the same time, ECB President Christine Lagarde confirmed last week that the Asset Purchase Program (APP) should be completed at the beginning of the third quarter. Her opinion was confirmed by the statements of other representatives of the ECB leadership. For example, European Central Bank Vice President Luis de Guindos said that "inflation is likely to remain at the 4%–5% range at the end of the year in the eurozone," and "the debt purchase program, the asset purchase program (APP) will probably end in July."

Economists now assume that the ECB will end the asset purchase program in June and raise the deposit rate (from -0.25% to 0%) in the 4th quarter of 2022. At the same time, they believe that due to weak GDP growth and subdued inflationary pressures, the scale of the rate increase will be small, falling short of more aggressive market expectations that the European Central Bank will raise the deposit rate by 200 basis points by the end of 2023. In addition, the situation and the military conflict in Ukraine significantly increases the risks of restoring the European economy, while the EU introduces new tough restrictive measures against Russia. First of all, this concerns Russian energy carriers, on which the European economy is very dependent, and some European countries are 100% dependent.

"Risks for forecasts depend on the situation in Ukraine and energy prices," the European Commission said today.

Despite the fact that the volatility in EUR/USD will remain quite high, while various verbal interventions and statements from representatives of the ECB leadership will rock the euro quotes, in general, there is still a strong bearish momentum that will continue to push the euro towards parity with the dollar.

"The EU economy is entering a troubled period," European Commission spokesman Dombrovskis said today, "and uncertainty and risks to the Eurozone's outlook remain high."

Tomorrow (at 09:00 GMT) Eurostat report will be published with the 2nd estimate of Eurozone GDP for the 1st quarter. According to the 2nd estimate, Eurozone GDP growth is expected in the 1st quarter of 2022 by +0.2% (+5.0% in annual terms). It coincides with the first estimate, which turned out to be slightly worse than the growth forecast by +0.3% (+5.1% in annual terms).

If the data turns out to be weaker than the forecast and/or previous values, then the euro may decline. Better-than-expected data may strengthen the euro in the short term, although the full recovery of the European economy, even to pre-crisis levels, is still far away.

Tomorrow is generally expected to be a very volatile trading day, primarily for the dollar and the euro. Updates on US retail sales will be released at 12:30 (GMT), followed by speeches by Christine Lagarde and Jerome Powell at 17:00 and 18:00. If they make unexpected statements regarding the prospects for the monetary policy of the Fed or the ECB, then the volatility in EUR/USD quotes may increase significantly.

In the meantime, everything is in favor of a further fall of this currency pair. A break into the zone below the recent local and multi-year lows near the 1.0350 mark may open the way for further decline, and as they say, it will be within easy reach to the 1.0000 mark.