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USD has no hope
On Thursday, the dollar bears continued to hold the reins of power and initiated another big sell-off in the American currency. USD depreciated against the basket of major currencies by 0.45%, dropping to almost a yearly low of 100.78.
The euro benefited the most from the dollar's decline. At the end of yesterday's trading, EUR/USD soared by more than 0.5%, and this morning, it reached a yearly high of 1.1075.
The reason for the sudden decline in the US dollar was further weakening of investors' hawkish expectations regarding the Fed's monetary policy.
On Wednesday, speculation flared up that in June, the US central bank may pause the tightening cycle and then move to rate cuts.
The weak inflation report in the US for March contributed to the dovish sentiment. Last month, the rise in consumer prices slowed down more than expected, reaching only 5% on an annual basis, while in February, the CPI jumped by 6%.
Traders saw clear signs of disinflation and therefore, adjusted their forecasts for further rate policy.
Considering the fact that core inflation, which excludes volatile food and energy prices, remains stable on an annual basis, investors expect another round of monetary tightening by the Fed.
Currently, most market participants are inclined to believe that in May, the regulator will raise rates by 25 bps. Markets evaluate the probability of such a scenario at almost 70%.
However, traders are confident that the May rate hike will be the last one this year as the overall inflation in the US has not only plateaued but has also moved into the red zone.
According to market forecasts, by the end of the year, the interest rate in the US will decrease to 4.34% from the expected peak of 5.25%.
Yesterday, this dovish view was confirmed by a fresh batch of macroeconomic statistics. Investors received two weighty arguments pointing to an inevitable turn in the Fed's monetary policy in the coming months.
Firstly, there was another sign of weakening inflationary pressure in the US - a sharp drop in the producer price index.
In March, the annual growth rate was the slowest since January 2021, at only 2.7%. This is below the forecast of 3% and much lower than the February value of 4.9%.
Secondly, the possibility of a looming recession has once again resurfaced in the market as concerns over slowing economic growth have intensified after the latest US labor market report.
The weekly release showed that for the week ending on April 8, the number of initial jobless claims increased by 11,000 to 239,000. This is more than what economists were expecting.
"It seems like the US economy is finally out of steam after a year of rate hikes. It is already showing signs of slowing down, and the Fed is unlikely to exacerbate the situation in light of recent turmoil in the banking sector," Christopher Rupkey at FWDBONDS noted.
Euro full of optimism
Given the growing risk of a recession and the slowing inflation in the US, the market no longer believes in the hawkish stance of the US Federal Reserve, which cannot be said about the European Central Bank (ECB).
Currently, the majority of traders believe that the European regulator has much more room for further rate hikes.
Inflation in the eurozone remains high (at 8.5% year-on-year in February), and the European economy is feeling better than the American one.
The macroeconomic data released on Thursday gave a significant boost to the euro against the dollar. Industrial production in the EU grew by 2% on an annual basis in February, exceeding the forecast of 1.5% and the previous value of 0.9%.
Taking into account the positive economic situation and ongoing inflation in the eurozone, traders now expect the ECB to raise rates by 25 bps in May and make the same move in the middle of the year.
However, some European policymakers do not rule out the possibility of more aggressive tightening. Recently, Robert Holzmann, a member of the ECB Governing Council, supported an increase in rates by 50 bps. And yesterday, a member of the governing council, Bostjan Vasle, also voiced an opinion on a possible rate hike of half a percentage point next month.
As we can see, ECB policymakers currently have more hawkish ambitions than their American counterparts. If their rhetoric becomes even tougher when the March EU inflation data is published next week, it will serve as rocket fuel for the EUR/USD pair.
But let's not jump ahead. Today, the attention of EUR/USD traders will be focused on the publication of the US retail sales for March. Economists expect a decline from -0.1% to -0.4%.
A drop in retail sales indicates a cooling US economy and weakening inflation. If the forecast comes true, this will further weaken the market's hawkish expectations regarding the Fed's further monetary policy.
In this case, the US dollar will drop even further against the euro. If the EUR/USD pair does not fall below the February high of 1.1035 today, it has a chance to test the highest level since March 2022 at 1.1185.
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