At the beginning of the new week, the protective greenback turned out to be out of business, while risky assets, led by US stocks and the euro, visibly cheered up.
Currently, the greenback is trading about 1.5% below the two-week peak reached on October 13 in the area of 113.80.
Corrective forces may prevail in the short term, but the main bullish trend in USD should remain intact, according to ING strategists.
"A quiet week in terms of US data may lead to the fact that the correction of the dollar will last a bit. It is possible that the greenback will return to the 110 mark, which implies a fall of another 2%. However, the baseline scenario, in which not only the Fed, but also other central banks raise rates, increasing the threat of an impending global recession, should mean that the main bullish trend in the US currency remains intact," they said.
The dollar's retreat from recent highs and the growth of risk sentiment are being promoted by stronger-than-expected reports on the earnings of American companies for the third quarter.
"The results of the reporting season, which turned out to be better than fears, may well be the catalyst that the markets need to interrupt a stable decline," B. Riley Financial analysts noted.
The US stock market ended trading on Monday with strong growth. At the same time, the S&P showed the highest growth in two weeks. The indicator value increased by 2.65%, amounting to 3677.95 points.
Market participants also drew attention to data that showed that the Empire Manufacturing index, calculated by the Federal Reserve Bank of New York, fell to -9.1 points in October from -1.5 points a month earlier.
These data have added fuel to the fire of expectations that a turnaround from the Fed may appear on the horizon.
As a result, the S&P 500 managed to shrug off the losses of the previous week, when it lost 1.6%.
At the same time, the protective greenback came under pressure, allowing the single currency to overcome the weakness observed last week.
Amid improving market sentiment, the EUR/USD pair was able to move almost 120 points up from the previous closing levels. It ended Monday's trading near 0.9840, having gained about 1.1% during the day.
Key Wall Street indicators continued to rally on Tuesday, which limited demand for a safe dollar.
It seems that investors have taken into account in the quotes all the bad news that may materialize.
Market participants are trying to close their eyes to the risks of the Fed raising rates to a peak of 5%, as well as the risks of a recession in the United States.
The American economy will inevitably fall into recession over the next 12 months, according to an updated forecast by Bloomberg Economics.
According to this forecast, the probability of a recession is estimated at 100%, which is associated with persistently high inflation, which is at its highest in several decades, the tightening of the Fed's monetary policy and growing geopolitical tensions.
In the previous forecast by Bloomberg Economics, the chances of a recession in the United States were estimated at 65%.
Michael J. Wilson from Morgan Stanley noted that the 25% decline in the S&P 500 index this year forced him to test a serious level of support on the 200-week moving average, which could lead to a technical recovery to about 4150 points.
At the same time, Wilson maintains his overall negative long-term position on US stocks, which, according to him, will generally correspond to the rally in the bear market this year and in previous years.
The strategist warned that a sharp and significant slowdown in corporate earnings is expected over the next 12 months.
"In order to talk about the onset of a full-scale recession, the S&P 500 must fall below the key 200-week moving average, and this time the index will not be able to maintain this level, and therefore the rally in the bear market may not take place at all. Instead, the index may fall to 3400 points or even lower, while the "bottom" will be at the level of about 3000-3200 points," the expert said.
So far, the key Wall Street indicators remain positive, and increased risk appetite contributes to the growth of the EUR/USD pair.
On Tuesday, it rose to the highest levels since October 6 in the area of 0.9870.
The decline in energy prices in Europe also supported the single currency: the cost of blue fuel fell below $1,200 per thousand cubic meters for the first time since July 15.
"The EUR/USD pair fell below parity at the end of August, which was mainly caused by the negative consequences of the shock of rising energy prices. This energy shock was partially offset, as gas prices in Europe fell sharply due to warmer weather, as well as due to the fact that European governments as a whole reached target levels of reserves in storage," ING analysts said.
"A quiet week from the point of view of US data creates a window for a corrective rebound of EUR/USD, where the obvious target is the top of this year's bearish channel in the area of 0.9980-1.0000. We believe that this area will restrain the growth of the pair," they added.
The EUR/USD pair is trying to strengthen, but remains vulnerable and can turn back down very quickly, according to Commerzbank economists.
"The comments of the ECB Governing Council members indicate that there are disagreements about how far interest rates should be raised in the fight against inflation. And this, in turn, of course, depends on how much the European economy will suffer from high energy prices," they noted.
"ECB Chief Economist Philip Lane even pointed out that the central bank should deliberately leave open the level at which interest rates will peak in order to be able to respond to developments with some flexibility. Therefore, any potentially weak economic indicators can quickly extinguish the positive sentiment on the euro," Commerzbank reported.
Danske Bank lowered its forecast for EUR/USD, saying that the US dollar has yet to reach new highs, while the risks for the euro are strongly shifted downwards.
"We are lowering our forecast for the main currency pair and expect to see it at the level of 0.9300 in 12 months due to a significant negative shock in terms of trading conditions in Europe compared to the United States," the bank's specialists said.
They point out that the positive trade balance of the eurozone, due to the export engine represented by Germany, has completely turned into a deficit in 2022.
This is due to a sharp rise in gas and oil prices in Europe, an increase in the cost of imports and a blow to the region, which is a net importer of energy carriers, analysts said.
"The key factors underlying our currency forecasts are the further strengthening of the US dollar and the tightening of global financial conditions," Danske Bank said.
"The global economy will continue to slow down as leading central banks raise interest rates and consumers retreat in the face of rising inflation. Cyclical downturn traditionally favors the dollar, and this time is no different. It is important to note that the economic downturn has intensified further, supporting the US currency," the bank's strategists said.
"The movement to raise interest rates of central banks is led by the Fed, which continues to struggle with sticky and high inflation. This, in turn, creates an interest rate advantage for the dollar. In fact, the United States should remain a market with high interest rates. This means that America is likely to continue to attract capital, which in general will help the greenback maintain its strength," they added.
MUFG Bank analysts predict that in the coming weeks the EUR/USD pair will trade in the range of 0.9400-1.0200 with a bearish bias. They believe that the risk/premium balance for the pair's downward movement is becoming less attractive.
"The deterioration of growth prospects in the eurozone is not yet enough for the ECB to shift its focus from combating upward risks to inflation. The latest CPI report showed that core inflation moved to double digits in September," they said.
"ECB representatives have signaled that they want to return rates to neutral territory (about 2.00%) by the end of this year. They are also going to start discussions on reducing their balance sheet by allowing expiring assets to be sold, although these plans are unlikely to be implemented until the first half of next year. In general, the development of events still speaks in favor of maintaining a bearish mood for the euro for the next month, but the risk/premium ratio is becoming less convincing," MUFG Bank noted.
"The main risk for our bearish EUR/USD sentiment may be caused by further weakening of more acute problems with energy supplies in Europe. If the price of natural gas continues to fall/stop at lower levels during the winter, this could help ease concerns about an even sharper slowdown in the eurozone economy. At the same time, the single currency may strengthen more than expected if the ECB continues to raise rates at a faster pace, while its American counterpart will signal that it is considering slowing down the pace of rate hikes. This will contribute to a further narrowing of expectations regarding the divergence in the monetary policy of the Fed and the ECB," the bank's specialists said.