Following the results of Friday trading, the US currency showed the strongest one-day drop since November 2015. The USD index lost almost 2%, dropping to 110.60 points.
The demand for a protective dollar has undermined investors' hopes for an early revival of the world's second largest economy.
On the last working day of the previous week, there were reports that China will make significant changes to its policy on COVID-19 in the coming months.
In particular, The Wall Street Journal newspaper wrote, citing several sources, that Zeng Guang, a former leading epidemiologist at the Chinese Center for Disease Control and Prevention of the People's Republic of China, said that a significant change in the approach of the Chinese authorities to the coronavirus pandemic is expected in 2023.
Tracking the improvement in risk sentiment, key Wall Street indicators rose by 1.3-1.4% on Friday.
The rise in stocks and the decline in the greenback were supported by the US employment data for October, indicating that the labor market remains strong, but has begun to lose momentum for growth.
Thus, the number of jobs in the American economy increased by 261,000 last month. The rate of increase in the indicator slowed down compared to 315,000 in September and turned out to be the lowest since December 2020, although it exceeded the experts' forecast at the level of 200,000.
The average hourly wage in the US private sector increased by 0.4% compared to the previous month and by 4.7% year-on-year. At the same time, the rise in monthly terms accelerated compared to 0.3% in September, and in annual terms it slowed down from 5%.
Unemployment in the country rose to 3.7% in October from 3.5% in September.
"The October labor market data was the golden mean – not weak enough to hint at an impending recession in the US economy, but also not strong enough to signal to the Fed about the need for an even sharper rise in the key rate," State Street strategists noted.
"Some details of the report, including an increase in unemployment and a decrease in the level of participation in the labor force (from 62.3 to 62.2%), suggest that the labor market has begun to weaken, and this, in turn, shows that the tightening of the Fed policy is starting to work," they added.
Market participants took the October data on US employment as a signal that the Federal Reserve may slow down the pace of future rate hikes.
The Fed's final rate, or the level at which it will peak, fell to 5.09% late on Friday, from about 5.2% just before the release of the US labor market.
As a result, the dollar came under strong selling pressure, which helped the EUR/USD pair finish last week on a positive note. It jumped more than 200 points from the previous closing level of 0.9750.
At the start of the new week, the greenback rose by almost 0.5%, recovering to the area above 111.00 points.
This happened after Beijing reaffirmed its commitment to a zero tolerance policy for COVID-19.
Over the weekend, Chinese health officials said they would continue to respond dynamically to cases of coronavirus infection, without giving any signals of their intention to weaken quarantine measures.
The economic consequences of China's policy to combat COVID-19 were reflected in China's trade data published on Monday, which showed that exports and imports unexpectedly declined in October, which was the first simultaneous decline since May 2020.
In addition, Beijing reported 5,496 cases of coronavirus detected on November 6. This is the highest intraday increase since May 2, when strict quarantine measures were introduced in the country.
Amid weakening risk appetites, futures on major US stock indexes were trading down 0.5-0.7%, and the EUR/USD pair sank to local lows around 0.9900-0.9930.
However, the greenback quickly lost its bullish momentum, while Wall Street futures and the EUR/USD pair returned to positive territory.
Apparently, market participants still hope that the Chinese authorities will ease the restrictions, despite the increase in the number of new cases of coronavirus.
In addition, industrial production in Germany surprised us by showing growth.
The volume of industrial production in September in the largest economy of the eurozone expanded by 0.6% on a monthly basis, which turned out to be more than the expected growth of 0.2% and significantly better than the fall of 1.2% in the previous month.
A separate report showed that investor morale in the eurozone improved in November, for the first time in three months, reflecting hopes that falling energy prices will prevent rationing of gas consumption in the bloc this winter.
The Sentix investor confidence index in the eurozone rose to -30.9 points in November from -38.3 points in October. The index recovered from its lowest level since March 2020.
These data allowed the euro to resume positive dynamics and rise above parity with the dollar.
In the absence of important macroeconomic releases from the United States, investors' interest in risk continued to put pressure on the protective US currency.
The main US stock indexes are mostly rising on Monday.
Meanwhile, the USD index falls to multi-day lows and returns to the 110 area.
Macro factors continue to favor the greenback's growth, and corrections are mainly related to events caused by the compression of positions, according to ING analysts. They expect the dollar to strengthen again in the near future, but point out that there are two major risk events for the US currency this week: the October CPI report and the US midterm elections.
"The main attention will be focused on the monthly change in the basic consumer price index, which we expect to be 0.5%, which corresponds to the consensus. This will indicate further stability of the underlying price pressure and may prevent the markets from completely abandoning another Fed rate hike by 75 bps in December, which will eventually provide the dollar with a foundation. However, indicators below consensus may force us to reconsider the expectations for the rate in the direction of a dovish approach," ING analysts said.
"As for the midterm elections in the United States, the greater risk for the dollar is that the Republicans will gain control of both the House of Representatives and the Senate, which will mean the inability of the American administration to provide fiscal support in the economic downturn. The division of Congress (control of the House of Representatives will pass to the Republicans) may be mainly embedded in prices, and the consequences for the greenback may be relatively limited," they added.
"We expect more volatility in the foreign exchange market this week, but we remain bullish on the dollar in the near term and predict that in the coming weeks the USD will rise above 113.00," ING said.
HSBC economists believe that the dollar still has some growth potential until the end of the year, but this path remains data-dependent.
"We still believe that the dollar still has some growth potential until the end of the year, based on three factors: the Fed's hawkish policy, slowing global growth and risk aversion. Nevertheless, this path remains data-dependent, so for the greenback to rebound, inflation data will probably be required, sufficient for an additional Fed rate hike, while data confirming concerns about recession risks may cause a flight from risks, which will favorably affect the safe US currency," they said.
Having reached its highest in several decades at 114.10 at the end of September, the USD index has since been in a relatively narrow trading range between 110 and 113, say Westpac strategists, who believe that the dollar has already passed its peak.
"Expectations and risks associated with inflation continue to dictate the USD index to move within the range; although in the last month market participants have been increasingly concerned about the consequences of the US central bank's tough policy for the national economy and, accordingly, growing confidence that the peak of interest rates in the United States is already close," they said.
"Although the direction of the economy and, accordingly, consumer inflation in the United States is obvious, the markets are still afraid to take risks, especially while the Fed adheres to its hawkish position, which was again demonstrated last week by Fed Chairman Jerome Powell. We believe that the situation will not change until the end of the year. However, next year is likely to be very different. We think that USD will fall from the area of 113 to 103 by the end of 2023," analysts noted.
Westpac expects that by the end of next year, the EUR/USD pair will be able to recover to 1.0700.
"Our forecast is based on the elimination of downside risks associated with Europe's energy supply, since the continent's gas storage facilities are mostly full before winter, and the infrastructure necessary to replenish reserves until 2023 has already been created. We expect the EUR/USD pair to rise to 1.0700 by the end of 2023. If the winter weather turns out to be favorable, as the market increasingly suspects, then the upward risks for the euro may increase in the new year," the bank said.
Not only will the Fed's interest rate outlook depend on Thursday's U.S. inflation data, but whether the euro ends this week higher near three-month highs near $1.02 or returns to last week's lows just below $0.98.
"We don't quite understand why it is difficult for the market to come to terms with the idea that this is not a normal cycle. It doesn't take long to realize that the Fed has never stopped the tightening cycle below core inflation on an annualized basis. Why should the worst inflation shock in recent decades be any different," TD Securities analysts said.
"We expect the core consumer price index in the US for October to be 0.4% m/m (consensus forecast at 0.5%). We believe that we will need to see at least two, but probably three months of slowing of the main momentum before the markets can console themselves with the thought that the current estimate of the Fed's final rate is at least remotely close to correct," they added.
The FOMC's September forecasts implied that interest rates in the US could reach 4.5% by the end of this year and 4.75% at the beginning of 2023, but a press conference by Powell last week made the markets think that a possible peak in the federal funds rate is somewhere above the 5% level.
This strengthened the dollar and put pressure on the euro last week, and if we assume that any stronger than expected result of US inflation on Thursday will contribute to the resumption of speculation of this kind, it will create a risk for the current recovery of the EUR/USD pair.
"Since the weekly MACD momentum has already moved higher, this indicates the prospects for a deeper recovery. Exceeding the 0.9999 level adds weight to this opinion and may allow the EUR/USD pair to return to the recent high of 1.0095," Credit Suisse strategists said.
"Beyond 1.0095, the resistance is in the area of 1.0198-1.0201, where the September high and 23.6% correction of the downtrend of 2021-2022 are located. Support is initially observed at the level of 0.9898, and then – in the area of 0.9886-0.9883, near which the 13- and 55-day moving averages pass. Below, a drop to 0.9840 is possible, then to 0.9796," they noted.