25.04.202221:11 Forex Analysis & Reviews: EUR/USD: dollar stole the show from the euro again

The dollar is still among the favorites of the foreign exchange market, leaving the EUR/USD pair under pressure.

The single currency started the new week with a combative mood, reacting to Emmanuel Macron's victory in the second round of the French presidential election.

According to preliminary data, Macron won 58.55% of the vote. His rival, Marine Le Pen, a candidate from the National Association, received 41.45% of the vote. The final results of the vote should be summed up on April 27.

The EUR/USD pair opened with a bullish gap on Monday, but could not stay on an upward trajectory.

The euro's slight growth against the US dollar dissipated quite quickly, and the main currency pair collapsed, coming close to the 1.0700 mark.

In the run-up to the election, investors were concerned about Macron's relatively small margin from Le Pen, who advocated the nationalization of key industries, tax cuts and a reduction in French contributions to the EU budget.

Macron's victory is good news for the eurozone, as he is an ardent defender of European unity.

The election of Le Pen would lead to a clash with the EU and would cause a political crisis in France and, possibly, in Europe, where she would have few supporters.

Domestically, Macron is likely to continue to insist on some moderate reforms and some spending restrictions, although he will maintain a relatively soft fiscal policy.

In his victory speech, he admitted that many people voted for him only to prevent Le Pen from winning, and promised to pay attention to the fact that the standard of living of the French is falling.

In order to put his plans into practice, the new president will need to enlist the support of the parliamentary majority.

In June, the country will hold elections of deputies of the National Assembly, the lower house of the French parliament.

The outcome of these elections is still unclear. Therefore, Macron's victory was only a modest sigh of relief for investors.

The growing fragmentation of the political landscape in the country makes traders doubt that Macron's party will get an absolute majority in parliament this time.

In addition, a negative aspect of the presidential elections held in France for the markets may be a quick decision in favor of the Russian oil embargo, which will increase inflationary pressure and economic downturn in Europe.

The fact that Macron won the second round of the French elections gives only a short respite for the euro, according to MUFG Bank.

"The election result supports further integration into the EU in the future, as well as talks about further jointly financed fiscal incentives to help mitigate the negative consequences for European economies from the conflict in Ukraine," the bank's strategists noted.

"However, Macron is likely to continue to insist on a stronger response to Russia's special operation in Ukraine. The introduction of tougher measures, including restrictions on the supply of Russian energy imports to the EU, is still one of the main downside risks that European economies will face in the coming months. For the euro, a favorable result of the elections in France is clearly insufficient in itself to reverse the current bearish trend," they added.

Despite the victory of centrist Macron over far-right rival Le Pen, there were not so many people willing to buy the single currency.

Although Macron won the second round against Le Pen, however, only 58.5% of voters supported him for a second term (against 66% in 2017), economists at Commerzbank say.

The fact that more than 40% of the population voted anti-European in France means that every five years there will be a risk of a change in the world picture for the eurozone and the single currency, they believe.

The EUR/USD pair managed to win back a small part of the intraday losses, but it continues to trade deep in negative territory.

"Macron strengthened his lead in the polls a few days before the election, so the result was not a big surprise. In addition, at the moment the markets have something to worry about, and this outweighs the effect of Macron's victory," ING strategists said.

A wave of risk aversion swept through global markets on Monday, increasing the dollar's appeal as a safe haven to the detriment of the single currency.

"The week begins with a sharply negative tone in the world markets, which pay attention to the following: a) many central banks are accelerating their tightening plans, b) Russia and Ukraine are moving further away from a diplomatic solution to the conflict, c) the COVID crisis in China is forcing us to reconsider growth expectations in the region," ING said.

The combination of these factors allowed the USD index to move the March 2020 highs to 101.80, setting the next target at 102.00.

"We think it's too early to become bearish about the US currency. If global economic activity declines in the face of tightening monetary policy, geopolitical risks and a reduction in real incomes, then the greenback will not be among the most vulnerable," HSBC said.

According to Piper Sandler analysts, by the end of next year, the United States is likely to go into recession as a result of aggressive tightening of monetary policy to combat inflation, but still the American economy has better prospects than the European one, and this will support the dollar.

The greenback is having a good month. It grew by 2.3% in April, which is the best result since June 2021. The dollar has been strengthening against the euro for the fourth consecutive month. The divergence in the monetary policy of the Federal Reserve and the European Central Bank is still the main driver of the EUR/USD pair.

Last week, Fed Jerome Powell made headlines by saying that a 50 basis point rate hike would be discussed at the next FOMC meeting, adding that it was advisable to act a little faster to combat inflation.

In March, the US central bank raised the key rate by 25 basis points, to 0.25–0.5%.

Judging by the futures on the rate level, the market is almost certain that the Fed will increase the cost of borrowing by at least 50 bps at each of the next two meetings – in May and June. According to the CME Group, traders estimate a 94% probability of a rate hike by 75 bps in June. The rate has not been raised by 75 bp since November 1994.

This week begins the so-called "period of silence" before the Fed meeting, which will take place on May 3-4, which means that the players will have to "digest" the already existing signals from the central bank.

"The markets are very concerned about the growing likelihood of a mistake in the Fed's policy. When a representative of the Fed proposes a 50 basis point rate increase, the markets immediately start trying to raise the price by 75 basis points," said Harris Financial Group analysts.

Many analysts believe that by the end of the year, the federal funds rate will be in the range between 2.75% and 3%, which is much higher than the March FOMC estimate of 1.9%.

Deutsche Bank strategists believe that the combination of aggressive rate hikes and the rapid winding down of the Fed's balance sheet will plunge the US economy into recession next year.

On Thursday, the United States will publish a preliminary estimate for the growth of the national economy in the first quarter. The country's GDP is expected to slow sharply from 6.9% in the last quarter of 2021 to 1.1% amid the effects of the omicron pandemic wave at the beginning of the year.

On the other side of the Atlantic, the focus will be on eurozone inflation data for April.

According to forecasts, the consumer price index will be 7.4%, which is almost four times higher than the ECB's target of 2%.

On Sunday, ECB President Christine Lagarde said that 50% of the increase in inflation in Europe is caused by the rise in energy prices, which is largely due to the situation related to Ukraine.

She added that at the moment, an increase in interest rates will not help to put pressure on the cost of energy.

Meanwhile, Reuters reported on Monday that ECB policymakers want to end the asset purchase program as soon as possible so that they can raise the discount rate as early as July, if necessary.

According to the futures quotes for the rate level, the market lays down the probability of its increase by 25 basis points, both in July and in September.

A noticeable divergence in exchange rates between the ECB and the Fed indicates against any sustained recovery of the EUR/USD pair. Further growth of the dollar may trigger a breakthrough below 1.0700, ING strategists note.

"The fragmented French electorate and concerns about energy security in Europe continue to cloud the prospects for the euro. A strong US dollar suggests that a sharp rebound in EUR/USD may be unattainable in the near term. Nevertheless, the tone of the ECB meeting on June 9 is likely to play an important role in determining whether EUR/USD can recover moderately," Rabobank analysts said.

"We believe that EUR/USD will end the year higher around 1.1000. This point of view depends on the assumption that the ECB will start raising rates, and on the opinion that investors will prepare for a slowdown in economic growth in the United States next year. The possibility of another COVID-19–related wave of economic uncertainty coinciding with the Fed's aggressive tightening is likely to lead to a longer-term strengthening of the US dollar," they added.

It will probably be difficult for the EUR/USD pair to gain momentum if there is no revival of interest in risk in the markets.

So far, it is difficult for investors to return to optimism, and the protective dollar continues to be in demand, reaching new multi-year peaks.

It is obvious that the Fed remains on a much more aggressive path of tightening than the ECB, and this divergence in policy favors the greenback compared to the single currency.

"If the EUR/USD pair maintains a bearish mood, the bears' next target will be the 1.0675-1.0674 area and, ultimately, the 2020 low at 1.0635. A net breakthrough of the last level will bring the April 2017 low at 1.0579 into play, and then the area of 1.0496-1.0493," Credit Suisse believes.

"The initial resistance is at 1.0758-1.0760, then at 1.0836-1.0859, and this area should limit the growth. A breakthrough above may lead to a recovery to 1.0933-1.0934. A breakdown of this area will mean the completion of the formation of a short-term base and will clear the way for a rise to 1.1034-1.1040," the bank said.