A strong wave of risk aversion swept through the financial markets on Monday. The flight of investors to safe havens helped the protective dollar consolidate the previous week's achievements.
The greenback rose 0.8% against its main competitors on Monday, finishing not far from the two-decade peak of 109.30 reached in mid-July.
Meanwhile, key Wall Street indicators ended Monday's trading with the highest decline in two months. In particular, the S&P 500 decreased by 2.14% to 4,137.99 points, continuing the previous week's rollback by 1.2%. Before that, the indicator had been growing for four consecutive weeks.
There was no significant news the day before. In the absence of important statistics, traders focused on how hawkish the statements of Federal Reserve Chairman Jerome Powell will be at the annual event of the US central bank at the end of the week.
The increased risk of a hawkish signal from the Fed symposium in Jackson Hole is one of the main reasons why investors sought refuge in USD on Monday.
It is assumed that Powell will emphasize the importance of raising the discount rate to combat inflation and remind of the need to tighten monetary policy. Expectations of such actions by the Fed served as a tailwind for the dollar.
The greenback has been growing relentlessly since the minutes from the July Fed meeting were published last Wednesday.
The document testified to the central bank's determination to reduce inflation, but did not contain clear signals about the pace of rate hikes.
Futures for the federal funds rate put in quotes a 51% probability of its rate hike by 75 basis points in September, while the chances of an increase in the cost of borrowing by half a point are 49%.
This puts the focus on the speech of Powell in Jackson Hole on Friday, which may give an idea of the future trajectory of the US interest rate.
"The market fears that the Chairman of the Federal Reserve J. Powell will dispel the hopes for policy easing caused by his recent statements, and instead will give a clear signal that the regulator will have to move to tightening measures," TD Securities strategists said.
The upcoming Fed event in Jackson Hole is starting to unnerve market participants, PineBridge Investments analysts say.
"After the July FOMC meeting, investors had the opinion that the US central bank would be less aggressive in tightening monetary policy, since economic statistics have deteriorated, but there are rumors that Powell may try to change this perception among investors," they said.
According to experts, the dollar can benefit if the Fed chairman leads the markets to higher levels of US interest rates for September and beyond.
"We suspect that the Fed has a lot of work ahead of it. It is too early for the central bank to turn around, and the comments of officials after the release of July inflation data in the United States suggest a concerted effort to ease speculation that the central bank's work is almost complete due to just one good report on the consumer price index," MUFG strategists believe.
JPMorgan analysts expect another major Fed rate hike in September, but after that, in their opinion, the central bank will not surprise the markets again with its unexpectedly hawkish position.
"We expect that in the future the Fed will seek a compromise between economic growth and monetary policy, which will contribute to the recovery of the US stock market as a whole," they said.
The bank predicts that the stock market recovery may last until the end of the year, which is due not to the pace of the Fed rate hike, but to the slope of the yield curve.
At some point on Monday, the difference in yields between 2-year and 10-year treasuries reached more than -30 basis points, signaling that the United States is in for a deep recession, or it has already begun.
At the same time, JPMorgan strategists consider themselves to be an endangered species of bulls on Wall Street.
Morgan Stanley analysts warned that the bear market is not over yet, and the shares have not yet reached the "bottom". Companies will revise profit forecasts downward, which will increase pressure on quotes, experts say.
The seasonal factor shows that profit forecasts are significantly deteriorating over the next two months, and this year will not be an exception to this historical pattern, Morgan Stanley notes.
"Many focused on the data on the labor market and inflation, namely, how they will affect the Fed's policy, but we, among other things, made a number of fundamental conclusions. The combination of sustained, higher wage costs and a slowdown in the end market/consumer pricing signals margin pressure that contradicts optimistic consensus estimates," the bank's analysts said.
Morgan Stanley's forecasts are consistent with the position of some other strategists on Wall Street.
BlackRock analysts believe that American companies will lose profits, and the Fed will raise rates to a level at which the restart of the economy will simply stall. In their opinion, the summer stock market rally is unstable.
The recent strengthening of the dollar is due to the revision of expectations in the futures market for the federal funds rate. The quotes now include a scenario according to which interest rates will rise to 3.75% and will remain in this area at least until July next year. That is, the futures market now expects not a reduction, but an increase in the Fed's rates.
When financial conditions tighten, stocks tend to fall. So there is nothing surprising in the decline in key Wall Street indicators.
The main US stock indexes closed deep in negative territory on Monday while the greenback rose in all directions. The USD index reached a more than five-week high of 109.02 the day before.
The weakening of the euro is also behind such dynamics of the dollar. The EUR/USD pair ended Monday's trading below the parity level for the first time since the end of 2002, finishing in the area of 0.9940.
Part of the euro's movement could be caused by low summer liquidity in the market, and part by currency flows, but the main news that had a negative impact was the increase in gas prices, Societe Generale analysts believe.
The price of blue fuel in Europe sharply went up and broke through the mark of $3,000 per thousand cubic meters on Monday.
The latest jump in gas prices occurred after the Russian company Gazprom announced last Friday that on August 31, the Nord Stream-1 gas pipeline would be closed for scheduled three-day maintenance.
"Some market participants fear that supplies via Nord Stream-1 will not recover after the September maintenance. In such a scenario, a significant additional reduction in demand is necessary to guarantee sufficient supplies for priority consumers, such as households and life support systems, therefore, without further reduction in consumption authorized by governments, we risk facing even more extreme prices," Energy Aspects analysts said.
Another jump in gas prices in the eurozone has increased concern about the region's economy. Against this background, the euro fell against the US dollar by almost 1%, demonstrating the worst indicator among the major currencies during yesterday.
The single currency has fallen in price due to renewed fears that an energy shock will keep inflation in the eurozone at a high level and make a recession almost inevitable, Reuters reports.
For most of Tuesday's trading, the EUR/USD pair remained under pressure and even touched the lowest levels in almost two decades in the area of 0.9900. At the same time, the dollar remained strong and was approaching multi-year highs set in mid-July, rising above 109.10.
Data published at the beginning of the European session from S&P Global showed that the composite purchasing managers' index of the eurozone in August fell to a low in a year and a half, amounting to 49.2 points, but at the same time being above the forecast of 49 points. These data could not provide significant assistance to the euro, as they indicated a contraction of the regional economy in the third quarter of this year.
The dollar loosened its grip only after S&P Global reported that the composite index of business activity in the United States this month fell to 45 points, which is the lowest since February 2021.
After the release of the report, the USD index sank to 108.00 points before regaining some losses.
Amid the greenback's retreat from multi-year highs, the main currency pair jumped by more than 100 points, but then rolled back, reducing intraday profit.
The main trend in EUR/USD remains bearish, as the factors exerting pressure on the pair persist. This suggests that attempts to restore it are likely to remain technical corrections.
Hawkish market expectations before Powell's speech on Friday in Jackson Hole should still support the dollar fairly steadily, and pro-cyclical currencies (in particular, the euro) are likely to retreat, as the global risk sentiment remains unstable, according to ING strategists.
The main US stock indexes mostly declined on Tuesday on concerns about the prospects for the global economy.
"We may see USD at 110 by the end of the week, and even at this level it will be risky to talk about reaching a peak for the dollar," ING reported.
Potentially, the road opens for the dollar to the highs of 2000-2002, near 120, which implies the growth of the US currency by about 10% more from current levels.
BBH economists believe that USD may rise in the direction of 121 when the July highs break in the area of 109.30.
"There are no significant obstacles above the peak levels of July in the area of 109.30 until the high of January 2002 in the area of 120.50 and the high of July 2001 in the area of 121," they said.
The combination of the Fed's hawkish position and continuing concerns about global economic growth should ensure a slight strengthening of the US dollar in the next few weeks, HSBC analysts believe.
"We expect that Fed Chairman J. Powell will confirm the current position, and the market will justifiably balance between raising the rate by 50 bps and 75 bps, which supports the idea of the US dollar moving sideways. However, we believe that other factors, such as higher new median rate forecasts (in particular, a higher final rate level forecast), may be sufficient to push USD higher," they said.
HSBC predicts that the world's most popular currency pair will continue to move downward.
"A lot will depend on the development of events and the results of the ECB meeting on September 8. Currently, the market is pricing in an increase in the cost of borrowing in the eurozone by 52 bps, which is in line with our expectations. Even if the ECB provides a 75 bps rate hike (not our central forecast), we are not sure that this will have a positive impact on the euro, apart from a short initial reaction, since the foreign exchange market has switched its attention to the prospects for global economic growth, and not to the local rate hikes," bank analysts said.
It is worth noting that the continuing difference in interest rates on both sides of the Atlantic plays against the euro in favor of the dollar, as well as the European Central Bank's lack of ability to keep pace with its American counterpart.
The EUR/USD pair seems to have found the "bottom" at the level of 0.9900. As long as this level remains unbroken, the pair can continue to recover in the direction of 1.0000. If this mark turns into support, the bulls' next targets will be 1.0025 and 1.0050.
On the other hand, a close below 0.9900 will open the way for further decline and will bring the 0.9870, 0.9840 and 0.9800 levels into play.