FX.co ★ The dollar is returning to the old reality

The new is the well-forgotten old. Unfortunately or fortunately, the new reality for the world economy has not arrived. Inflation is slowing down even without further rate hikes by the world's leading central banks. And they are thinking about how to save the economy from excessively high borrowing costs. At the forefront, as usual, is the Federal Reserve, which is causing the US dollar to fall. It's no wonder that even before the end of 2023, the EUR/USD bulls stormed the 1.1 level.

Back in October, the yield on US Treasury bonds exceeded the 5% mark, there was a lot of talk about the new reality. About the fact that rates will remain high for an extended period. That the economy needs to adapt in order to avoid triggering another surge in inflation, as in the 1970s. As a result, American assets became more appealing, and the US dollar was sitting on the throne in the Forex market.

In the middle of autumn, fear dominated the stock market. The S&P 500 was trading too low. On the contrary, the yield on Treasury bonds was excessively high. They were getting rid of them, pouring massive resources into money market-oriented ETFs. We are talking about $1.3 trillion, which at the end of the year began looking for other uses. These turned out to be stocks and bonds. The broad stock index started conquering record highs, and the yield on 10-year bonds fell below 4%.

Everything seemed to turn upside down. Now the S&P 500 is no longer signaling an imminent decline. Rather, it signals a new surge in the US economy. On the other hand, bonds do not rule out a recession.

Leading indicators' dynamics and yield curve

Markets are seriously geared towards a soft landing. The decline in inflation to the target level against the backdrop of economic slowdown creates a favorable environment not only for stocks but also for EUR/USD. Moreover, not only the markets but also central banks are returning to the old reality.

There is an opinion that the Federal Reserve made a dovish pivot because the slowdown in inflation increases real interest rates. And this is bad for the economy. The European Central Bank was initially puzzled by the Federal Reserve's actions, and ECB President Christine Lagarde even sarcastically noted that unlike the US central bank, the European one does not have a dual mandate. However, later the concept was accepted. And even such a hawk as Isabel Schnabel of the Executive Board stated that further rate hikes are unlikely. Markets predict a 150 bps cut in 2024.

Market expectations for the ECB interest rate

This is approximately the same as the federal funds rate. With the same pace of monetary easing, the dynamics of the EUR/USD pair will be determined by risk appetite. And as long as it is rising, the main currency pair has a good chance of continuing its rally.

Technically, the formation of a doji bar on the daily chart indicates increasing risks of a pullback. It would make sense to use a break below the support at 1.099 for profit-taking on long positions and initiating short positions. However, as long as the pair is trading above this level, it's premature to give up on buying.