05.07.202208:42 Forex Analysis & Reviews: Dominant dollar and "low" euro: who will bear the recession easier?

The threat of a recession in the US and European economies worries the markets. In such a situation, key currencies can go to the bottom, although the greenback is more likely to stay afloat than the euro.

According to preliminary estimates, the US economy is steadily plunging into recession. Experts consider this to be confirmed by a noticeable decrease in economic activity (by 2.1%) recorded in the second quarter of 2022. Note that in the first quarter this figure did not exceed 1.6%.

As the inflationary spiral unfolded, American consumers began to spend more economically. According to current data on personal consumption spending in the US, real disposable income decreased by 0.1%, and consumer spending - by 0.4%. Recall that these indicators are closely monitored by the Federal Reserve.

According to currency strategists at Nomura Holdings Inc., during the next year, most countries will be covered by recession (primarily the US, Canada, Japan and the eurozone states). The reasons for this are the tightening of monetary policy and the increase in the cost of living. Against this background, the global economy expects a synchronous slowdown in growth, according to Nomura.

According to experts, a sign of such a slowdown will be the fact that "countries will not be able to count on a recovery in exports." The icing on the cake will be continued high inflation and increased price pressures that have spread to most goods and services, as well as wages.

At the same time, central banks are trying to control inflation, acting with varying success. According to economists, in the wake of panic about the recession, central banks can greatly "tighten the screws", that is, to conduct excessive tightening of the monetary policy. This will provoke another burst of recession, which will manifest itself in different ways in a number of countries. Nomura believes that the United States will be gripped by a "shallow but prolonged recession for five quarters." Experts expect it at the end of 2022. However, the economic downturn in Europe will be much deeper than in America. A similar scenario is possible if Russia completely blocks gas supplies to the region.

Against this background, the demand for safe haven assets is increasing, primarily for the greenback. This development keeps the euro near a five-year low. Traders and investors are massively withdrawing into the dollar amid concerns about a slowdown in global economic growth. According to analysts, further tightening of financial conditions contributes to the strengthening of demand for USD amid flight from risk.

At the beginning of this week, the single currency was under pressure from a stronger American rival in the EUR/USD pair. Recall that last week the euro did not receive support from macroeconomic data, as they turned out to be ambiguous. At the same time, inflation in the eurozone reached a record high of 8.6% in June (compared with the May figure of 8.1%). This forced European Central Bank President Christine Lagarde to take a hawkish position on further rate hikes. According to Lagarde, in such a situation it is advisable to raise interest rates by more than 0.25%.

In the current situation, the US currency continues to dominate the financial market, although key US stock indexes remain under pressure. Many market participants still prefer the dollar, which contrasts with the weakening euro. On the morning of Tuesday, July 5, the EUR/USD pair was trading at 1.0434, almost without going beyond yesterday's price range.

The US currency, being a safe haven asset, seized the initiative from other defensive instruments such as the yen, gold and US government bonds. A similar situation emerged after the market's focus shifted from concerns about inflation to expectations of a recession in the US. At the same time, market participants expected the Fed to raise the rate to 4%.

Earlier, at the Fed's June meeting, most representatives of the department planned to raise interest rates to a moderate range (from 3% to 3.5% by the end of 2022). In 2023, rates were expected to rise to 4% or more to curb inflation. However, the current situation introduces its own adjustments, which must be taken into account and, if necessary, review previous decisions.

According to preliminary forecasts, financial conditions may worsen in the third quarter of this year. Against this background, the Fed is forced to carry out the most rapid and powerful tightening of monetary policy in decades. In such a situation, experts expect further strengthening of the greenback and subsidence of the euro. However, by the end of 2022 - the beginning of 2023, changes are possible in this regard. According to MUFG Bank economists, the dollar will rise during this year, then turn down. If such a scenario materializes, the euro will have a chance to recover.