The EUR/USD closed the trading week at 1.0849, a four-week low. There is no doubt that if trading had not stopped because of the holiday, the EUR/USD bears would have pulled the price to the base of the 8th figure and probably to the support level of 1.0780 (that is the lower limit of the Kumo cloud on the daily chart).
The downward dynamics of the pair were due solely to the strengthening of the US currency: on Friday, the US dollar index renewed a five-week high, rising to the 102.50 mark. The euro behaved quite calmly in key cross-pairs, which suggests that the greenback, which is taking advantage of the current situation, has become the driving force of the downward movement of EUR/USD. The growth of risk-off sentiment strengthened the safe-haven dollar, which ignored many of the most important fundamental factors (for example, slowing inflation in the US). Given such "isolation", an obvious conclusion can be made: the revaluation of the US currency is temporary and situational. The EUR/USD pair is declining on rather shaky grounds, so short positions are still risky, despite the rapid plunge in price. Factors that are now pulling the pair down usually don't "live long".
"Classic" fundamental factors - against the greenback
The economic calendar for the upcoming week is generally full of macroeconomic events. Among the key reports are the US retail sales data; the German business sentiment index from the ZEW institute (Tuesday, May 16), building permits issued, the second estimate of the eurozone Consumer Price Index (Wednesday, May 17), the manufacturing index of the Philadelphia Fed; secondary housing sales (Thursday, May 18), the German Producer Price Index (Friday, May 19). In addition, many representatives of the Federal Reserve will speak throughout the week: in particular, Neel Kashkari, Michael Barr, John Williams, Lorie Logan, Austan Goolsbee, Philip Jefferson, Michelle Bowman, and even Fed Chairman Jerome Powell (his speech is scheduled for Friday).
Take note that the dollar strengthened its positions last week due to the growth of risk-off sentiment in the markets. Whereas "classic" fundamental factors, on the contrary, worked against the US currency. For example, the CPI reflected slowing inflation in the US. The rest of the inflation indicators, published last week, came out in the "red zone", complementing the overall picture. For example, the PPI was at its lowest level since January 2021. A similar dynamic was demonstrated by the core index, which is also falling much faster than most experts' forecasts. The "icing on the cake" here are Friday's reports. The US import price index fell to -4.8% y/y (the indicator is in the negative area for the second month in a row), and the consumer sentiment index from the University of Michigan dropped to 57.7 points (a four-month low).
Amid such releases, hawkish expectations regarding the Fed's future actions significantly weakened in the market. Thus, according to the CME FedWatch Tool, the probability of a 25-point rate hike at the June meeting is 15% (accordingly, the probability of maintaining the status quo is 85%). As for the possible prospects of the July meeting, the situation here is even more interesting: the probability of a 25-point rate cut (with the status quo maintained in June) is estimated at almost 30%. This is quite a lot, considering the fact that Powell has repeatedly denied the option of easing the monetary policy parameters within the current year. The "base" scenario for the July meeting is to maintain a wait-and-see position (probability - 60%).
Thus, despite the slowing inflation in the US and the significant weakening of hawkish expectations, the dollar index renewed a 5-week high, benefiting from the strengthening of risk-off sentiments.
All of this suggests that as soon as the market's interest in risk resumes, the compressed spring can unwind in the opposite direction - and in this case, the beneficiaries of the current situation will be the EUR/USD bulls.
Dollar's Allies
What needs to happen for the market to come to its senses again and for the safe-haven dollar to be under pressure? In my opinion, successful negotiations between Republicans and Democrats on raising the debt ceiling will become the catalyst for a price rollback.
On Saturday, US President Joe Biden said that talks with Congress on the debt limit were moving along and more will be known about their progress in the next two days. According to Reuters, Biden will meet with Republican House Speaker Kevin McCarthy and other congressional leaders early next week to resume negotiations that stalled last week (by the way, it was this fact that significantly strengthened the greenback's position). According to an inside source from American journalists, Biden's and McCarthy's aides have already begun discussing ways to limit federal spending in order to resume negotiations on raising the debt limit.
If American politicians find a compromise, it will be a strong blow to the positions of dollar bulls. However, even the mere fact of resumed negotiations can weaken the greenback.
Also, EUR/USD traders will also focus on the "well-being" of another shaken bank in the US. As is known, shares of the California lender PacWest Bancorp plummeted after the company reported losing a significant portion of its deposits.
Amid a series of spring bankruptcies (Silvergate, Signature Bank, Silicon Valley Bank), US Treasury Secretary Janet Yellen allowed the merger of several regional banks in the country. According to her, the current banking environment and pressures on earnings of some U.S. regional banks may lead to some concentration in the sector. Meanwhile, the authorities "are highly likely" to approve such mergers.
However, according to the Financial Times, despite the banking crisis, the profit of the US banking sector reached a record high in the first quarter - approximately 80 billion dollars. Preliminary estimates suggest that profits grew by 33% compared to the same period last year.
It can be assumed that if the markets are not shaken by another bankruptcy in the near future (considering the difficult situation with PacWest), the topic of the banking crisis in the US will gradually fade into the background, thus depriving the dollar of another trump card.
Conclusions
To summarize, it should be emphasized: the dollar has received strong, but temporary support. Most of the "classic" fundamental factors - are not on the side of the greenback, especially in light of the results of the Fed's May meeting (where the fate of the interest rate was effectively "tied" to the dynamics of inflation growth in the US).
At the same time, it is imprudent and risky to play against the dollar until the negotiations on the US debt limit are completed. For example, in 2011, the standoff between President Barack Obama and the Democratic Senate with Republicans in the House of Representatives lasted until the last moment. The risk of default was so real that traders were gripped by panic, and the US credit rating was downgraded. It is quite likely that the current situation will unfold according to a similar scenario. In this case, the dollar will continue to gain momentum across the market, including with the euro. But if negotiations, which will resume, are productive, then the compressed spring will unwind in the opposite direction.
Therefore, at this moment, it is better to maintain a wait-and-see position for the EUR/USD pair.