31.05.202207:12 Forex Analysis & Reviews: Is the dollar-protection clamped in the grip of risk appetite?

At the beginning of this week, the US currency faced quite strong pressure amid increased risk appetite. The euro took advantage of this, which managed to benefit from the subsidence of the greenback.

The euro is supported by expectations of a rise in the key rate from the European Central Bank. According to analysts, the current inflation statistics in the short term may force the central bank to raise the rate by 50 bps. According to the reports provided, in May consumer inflation in Germany increased to 8.7% Y/Y, exceeding the forecast of 8.1% Y/Y and leaving far behind the April figure of 7.8% Y/Y. The data provided increased pressure on the ECB, forcing it to resort to more active measures to curb the inflationary spiral.

According to Philip Lane, the ECB's leading economist, the process of monetary policy normalization will be gradual. Thus, the official confirmed ECB President Christine Lagarde's intention to end the multi-year period of negative rates by the end of September 2022. Earlier, Lagarde agreed to increase the interest rate by 25 bps in July, and then in September by a similar amount. It is expected that the ECB deposit rate, which currently stands at -0.5%, will turn to zero.

Such a strategy undermines the position of the greenback. Despite the actions of central banks, in particular the Federal Reserve and the ECB, which have taken a course to tighten monetary policy, Rabobank economists are confident that in the coming months the demand for safe assets will support USD. The current subsidence of the latter was also facilitated by a possible slowdown in the process of the Fed tightening the monetary policy. The long rally of the EUR/USD pair on the world stock markets undermined the dollar's position. At the same time, the recent hawkish comments by ECB representatives hinting at the curtailment of the negative interest rate regime in the eurozone gave an impetus to the euro.

In the current situation, the EUR/USD pair showed enviable stability, starting the new week on a positive note. As a result, the pair rose to a new monthly high amid massive sales of greenback. The EUR/USD pair was cruising near 1.0746 on the morning of Tuesday, May 31, winning back yesterday's losses.

In the future, traders continued to reduce their long positions on USD due to fears that the Fed will suspend the cycle of rate hikes after two rises of 50 bp each, scheduled in June and July.

Experts pay attention to the fragile nature of the current market sentiment, expecting high volatility in the market in the coming months. According to preliminary calculations, the surges in dollar sales will be short-lived. Against this background, the risk of another drawdown of the EUR/USD pair to the critical 1.0300 increases in the future of two to three months.

According to analysts, the current aggressive monetary policy of the ECB supports the European currency and puts pressure on the American one. Against this background, the greenback fell into the trap of market expectations of an early tightening of the monetary policy by central banks. Short positions on USD added fuel to the fire, which tripped it, but allowed the euro to strengthen its position.