At the beginning of last week, the key Wall Street indexes cheered up after a sharp drawdown from record highs.
The optimistic forecasts of leading investment banks that stocks will be able to withstand even a rise in the Federal Reserve's interest rates and an increase in the yield of treasuries contributed to the improvement of market sentiment.
A strong American economy and further growth in corporate profits were cited as positive factors that would keep stocks on an upward trajectory.
"Although investors should prepare for volatility due to the Fed's more hawkish line and a new wave of COVID-19 infections, we are still waiting for the rally to resume," UBS strategists noted.
"Undoubtedly, the stock market rally in the last quarter of 2021 reflects the sustainability of corporate profits. The results of the companies for the fourth quarter will support this trend, while forecasts for 2022 basically allow us to talk about maintaining the course, despite the continuation of the COVID-19 pandemic and problems in supply chains," said Citigroup analysts, who raised the estimate for the S&P 500 at the end of this year to 5,100 points from 4,900 points.
At the same time, market participants were not even confused by the words of Fed Chairman Jerome Powell that the United States no longer needed the ultra-soft monetary policy that operated during the pandemic-induced crisis and that the central bank was ready to move to raising interest rates in order to avoid overheating of the national economy.
Apparently, traders took into account the prospects of the Fed's first rate hike in March and four rate hikes in 2022.
In addition, they began to consider the risks from the new version of the coronavirus as if the pandemic this year will become much more manageable.
Due to the easier tolerance of Omicron compared to previous strains and despite its rapid spread in the world, investors lowered their estimates of its negative impact on the global economy. This supported risky assets and put pressure on the protective dollar.
The USD index broke through key support levels, dropping below 95.00 points and tracking a decline in the yield of treasuries amid increasing expectations that the tightening of monetary policy in the United States is likely to occur gradually.
The dollar's weakness also reflected the strengthened confidence of investors that the peak of inflation in the United States may have already passed.
Producer prices, according to data published last Thursday, increased in the country in December by 0.2% on a monthly basis and by 9.7% on an annual basis, which turned out to be lower than preliminary estimates - at the level of 0.4% and 9.8%, respectively. The market interpreted these figures as a signal of a weakening of inflationary pressure. This correlated well with the consumer inflation data released a day earlier, which did not exceed expectations.
Taking advantage of the greenback's weakness, the EUR/USD pair left the one-and-a-half-month range (1.1230-1.1385) and jumped by more than 100 points. However, it quickly lost its bullish momentum amid the sell-off of US stocks and the fall of key Wall Street indices, which lost their former confidence by the end of the past five days.
Touching the highest marks since November 2021 in the area of 1.1480 on Thursday, the EUR/USD pair retreated to 1.1450. After an unsuccessful attempt to extend the rally to 1.1500 on Friday, it rolled back even further from the two-month peak to 1.1415. At the same time, over the past week, the single currency has risen in price against the US dollar by almost 0.5%.
On Thursday, the S&P 500 index fell by 1.4%, the Dow Jones - by 0.5%, the Nasdaq - by 2.5%.
The US stock indexes ended Friday's trading in different directions, but declined at the end of the whole week. Dow Jones decreased by 0.9%, S&P 500 and Nasdaq - by 0.3%
Pressure on the market was exerted by investors' growing doubts about the sustainability of the economic recovery in the United States, as well as concerns about the tightening of the Fed's policy sooner than previously expected.
On Thursday, Fed Board of Governors member Lael Brainard said that inflation is too high and called its containment the most important task of the central bank.
Against this background, last Friday, the yield of ten-year treasuries rose to 1.793% from the previous closing level of 1.772%. This supported the US currency and allowed it to move away from the two-month low in the area of 94.60 points.
On Monday, the bond and equity markets in the United States did not work due to the celebration of Martin Luther King Day in the country. The greenback consolidated its recent losses, staying just above 95.00 points, and the EUR/USD pair was trading in the range of 1.1395-1.1430.
Since the long weekend, the main stock indexes of Wall Street have returned, to put it mildly, not in the best mood. The day before, they noticeably sank, and the sales were on a broad front, affecting almost all stocks.
Following the results of yesterday's session, the S&P 500 lost 1.8%, the Dow Jones lost 1.5%, and the Nasdaq completely collapsed by 2.6%.
Meanwhile, the yield of treasuries started a new working week with an update of the highs.
On Tuesday, the indicator for 10-year US Treasuries reached the highest levels since January 2020, rising above 1.85%.
This behavior of investors is explained by changes in expectations regarding the pace of tightening of the Fed's monetary policy.
If last week it was assumed that three or four rounds of federal funds rate hikes would take place this year, now the money markets are already putting four or five steps into quotes. But back in October, investors did not expect more than one increase in the cost of lending in the United States in 2022.
It is noteworthy that the VIX, the so-called Wall Street fear index, jumped to a one-month high, indicating a high level of uncertainty in terms of the Fed's future steps, or rather, the pace of normalization of monetary policy by the central bank. The nervousness is added by the corporate reporting season, which started on a minor note – several large American banks reported a deterioration in financial performance in the fourth quarter.
Against the background of weakening demand for risky assets, the USD index rose 0.5% yesterday, rising above 95.75 points.
Meanwhile, the euro was the main outsider of the foreign exchange market on Tuesday. The ZEW survey for Germany reflected an unexpected increase in the confidence of the country's business circles, which was supposed to support the single currency, but it fell following the sell-off on the US stock market.
The Fed's first meeting of the year will be held next week. Real steps in the framework of policy adjustments are unlikely to be taken by the central bank before March, since it will certainly want to wait for reports on the current outbreak of Omicron. Nevertheless, there is a small probability of an increase in the federal funds rate as early as January, and the prospect of an aggressive tightening of the policy of the US central bank in the form of a rate hike next week (or an increase of 50 basis points in March) scares investors.
The market's fear of the Fed's future actions may well send the USD index to new local highs in the medium term. This will correspond to the seasonal trend – the dollar tends to strengthen at the beginning of the year.
The greenback faced strong resistance in the area of 95.80, lost some of the previously scored points and rolled back to the area of 95.50 on Wednesday.
Currently, the dollar receives support in the form of a four-month support line (from the September low), passing around 95.25. As long as the USD index remains above it, it will retain the potential for continued growth.
The next significant target is at 96.46 (the current highs of this year from January 4) and then at 96.93 (the 2021 high from November 24).
US stock indexes opened higher on Wednesday, adding an average of 0.2-0.4%, as the market calmed its nerves somewhat.
The EUR/USD pair also recovered slightly after a decline of about 0.7% on Tuesday, which was the sharpest daily drop in a month.
Scotiabank strategists believe that while the pair is trading at 1.1350, it will retain the drawdown potential at 1.1300, primarily due to the continued divergence of the ECB and Fed rates.
"We expect a breakthrough below 1.1300 in the coming weeks and eventually testing the level of 1.1000 against the background of the beginning of the Fed policy tightening cycle. To recover to the 1.1450 area, the pair should break above 1.1350 and 1.1375-1.1385. The initial support is in the area of the 50-day moving average at 1.1322. Further, support levels are marked at 1.1300 and in the area of 1.1280-1.1285," they said.