The U.S. dollar index hit a three-week high Tuesday amid rising risk sentiment, a declining U.S. stock market, pessimistic comments from the IMF head, disappointing news from China and political turmoil in the House of Representatives. All these fundamental factors allowed dollar bulls to remind itself again—also in pair with euro, which found itself under additional pressure against the background of the failed German inflation data. After briefly soaring to the 7th figure area earlier this week, the EUR/USD pair dropped to 1.0520 on Tuesday, updating the three-week price low.
But at the start of the European session on Wednesday, the situation changed. The U.S. dollar index retreated from the local high, and the EUR/USD pair, in turn, retreated from the local low.
Let's take a closer look at the fundamental factors that led to yesterday's price decline and today's recovery.
According to the data published Tuesday, inflation growth in Germany slowed down more significantly relative to the corresponding forecast estimates. Preliminary estimates suggest that the general consumer price index rose in December by only 8.6% (in annual terms) against the forecast of a decline to 9.1%. The indicator has been falling for the second month in a row, which indicates a certain trend. On a monthly basis, the headline CPI came in at -0.8% (with a forecast decline to -0.6%). In this case, the indicator has been in the negative area for the second month in a row.
The harmonized consumer price index similarly turned out to be in the red zone, and here the numbers were more significantly short of the forecast estimates. On a monthly basis, the indicator fell to -1.2% (the weakest result since January 2015), with a forecast decline to -0.5%. On an annualized basis, the index fell to 9.6%, while experts expected a more modest decline to 10.7% (from the previous value of 11.3%). In other words, the inflation rate in Germany has slowed down significantly. And this fact is a warning signal that European inflation may also go into the red zone (scheduled for release on Friday).
The U.S. stock market also provided indirect support to the EUR/USD bears (due to increased demand for a safe dollar). U.S. stock indices ended the first trading session of the new year with a decline. In particular, the share price of Tesla collapsed by more than 12% in a day – to a minimum in more than two years. Apple shares lost 3.7% in price: the company's market value fell below the $2 trillion mark (for the first time since March of the year before last).
Disappointing macroeconomic data from China (Markit Manufacturing PMI, Official Manufacturing PMI) reminded traders of the implications of easing the zero-COVID policy. The unprecedented outbreak of the epidemic was reflected in December figures. Due to an increase in the number of coronavirus cases and disruptions in production chains, industrial activity in China fell sharply in December (in general, the contraction was recorded for the third month in a row).
Other fundamental factors only added to the overall picture yesterday, contributing to a stronger greenback. In particular, IMF Managing Director Kristalina Georgieva's comments that recession may affect one third of the world economy in 2023 influenced traders' mood to a certain extent. According to her estimates, the current year will be tougher than the previous one, as three major economies—the U.S., the European Union and China—are slowing down simultaneously.
The news that the U.S. House of Representatives, for the first time in 100 years, failed to elect a speaker on the first attempt was a kind of cherry on the cake. A split occurred in the camp of the Republican Party: the right-wing Trumpist Republicans actually blocked the vote, putting forward their political demands (primarily of a personnel nature). Given the fact that this is the first time such a situation has arisen since 1923, and the position of the speaker of the House of Representatives is the third position in the hierarchy in the U.S. power vertical, traders also reacted to this fact.
However, on Wednesday, buyers of EUR/USD were able to win back part of the lost positions due to several fundamental factors.
First, ECB Governing Council member Martins Kazaks made hawkish comments, saying he expects "significant rate hikes at the February and March meetings." Such words sounded quite unexpected, given the significant slowdown in German inflation.
Secondly, the notorious gas issue provided indirect support to the euro. Today it became known that the cost of gas in Europe has dropped below $750 per 1,000 cubic meters for the first time since February 18, 2022.
Thirdly, today's rise of the EUR/USD pair was caused directly by the decline in the U.S. dollar index. Traders took profits, thus interrupting the dollar mini-rally. Market participants do not risk investing in the dollar ahead of the events expected today during the American trading session. In particular, the ISM manufacturing index will be published today, which, according to forecasts, should fall to 48.5 points (in this case, the weakest growth rate of the indicator since May 2020 will be recorded). In addition, the minutes of the Fed's December meeting will be published towards the end of the day. This document can either strengthen greenback, or significantly weaken it, depending on the tone of the rhetoric of the Fed members. This is a major release given the controversial outcome of the December meeting.
Thus, EUR/USD traders de facto cannot decide on the price movement vector. After yesterday's decline to the bottom of the 5th figure, the buyers were able to seize the initiative, going to the area of the 6th price level. But the situation is uncertain—both for the bulls and the bears of the pair. In my opinion, in the current circumstances, it is necessary to take a wait-and-see attitude until the publication of the Fed's "minutes": the minutes of the December meeting can significantly strengthen/weaken the dollar, especially if the rhetoric of the document is clearly dovish or hawkish. Therefore, for the time being, it is advisable to be out of the market, at least in the context of the EUR/USD pair.