19.05.202208:23 Forex Analysis & Reviews: Fall after rise. Is the EUR/USD pair being pulled into the swamp?

After an impressive rise, the euro rolled back from the positions it had gained. However, the greenback could not take advantage of the opening advantage and also retreated a bit. As a result, the EUR/USD pair is stuck in a kind of financial swamp, from which it is trying hard to get out.

On the morning of Thursday, May 19, the US currency weakened slightly after strong growth the day before. The greenback, along with other defensive currencies, suspended its growth, but then began a gradual ascent. USD needed a short-term respite to catch its breath after a long week of recovery. The reason is the growing fears of the market regarding an overly aggressive tightening of the monetary policy by the Federal Reserve.

Against this background, the euro fell in price against the US dollar after the revision of inflation data in the eurozone. According to Eurostat, inflation did not accelerate at the end of April, as previously expected. According to last month's results, the agency's currency strategists adjusted the estimate of annual inflation to 7.4%. This indicator almost coincided with the preliminary estimate, implying an acceleration of inflation to 7.5%.

In the current situation, the euro, having lost its foothold, rushed down. The EUR/USD pair was trading at 1.0490 on Thursday morning, May 19, having lost its previous achievements. According to analysts, in the near future, the space for strengthening the pair will be reduced.

Markets are currently pricing in overly aggressive tightening of monetary policy, not only by the Fed. Investors fear that the ECB will follow the example of the US central bank. In such a situation, the global financial market will become hostage to high rates supported by central banks.

Raising key rates is good for the greenback, but the seriousness of the Fed's intentions in this matter is alarming. Fed Chairman Jerome Powell confirmed that he is ready for tough measures to reduce inflation in the country, primarily to further raise the interest rate.

Recall that this year the Fed raised the key rate twice and is ready to do it again. The reason is surging inflation, for which all means are used to contain it. However, the increase in rates contributes to the increase in the cost of mortgage lending, high interest rates on loans and difficulties in borrowing.

To abandon the current tightening of monetary policy, the central bank needs strong evidence of a slowdown in inflation before the Fed abandons its aggressive hike in interest rates. According to Powell, the Fed is set to further increase the key rate by 50 basis points (bp) at the next meetings (in June and July).

The current rhetoric of the central bank coincided with market expectations. Currency investors were once again convinced that the Fed will follow the chosen course aimed at raising the rate in order to ease inflationary pressures. A stop in this process is possible only when the target inflation rate of 2% per annum is reached, analysts believe.

This week, hawkish comments from Fed officials have helped lift the euro. However, now the pair has stopped showing new movement and the EUR/USD pair is marking time, trying to get out of the existing range. The current situation has a negative impact on the state of financial markets, which have to operate in the face of risks associated with changes in interest rates due to persistently high inflation. As a result, the market moves in a vicious circle, which negatively affects the short-term dynamics of the EUR/USD pair. In the current situation, it will be difficult for the Fed to return to the usual practice of flooding the markets with liquidity, given its bloated balance sheet and current inflationary fears.

Against this background, the risks associated with too rapid strengthening of the USD increase. According to experts, they can be reduced in the course of structural reforms in a number of economies. This will help increase labor productivity, increase the return on capital and the stability of the global economy, experts conclude.