Forex Weekly Analyses

With near-term sentiment now in a “corrective” mood, it looks likely that this US dollar retracement can extend a bit further. Sideways consolidation also looks like a probable scenario. That being the case, the long-term dynamics haven’t been altered, and the predominant bullish trend should remain intact. Fed communication is still firmly hawkish, and quantitative tightening (QT) and 50bp rate hikes will happen in the coming months. In contrast, other central banks fall significantly behind the Fed in terms of tightening policy. This divergence between the central banks should continue to support the USD and eventually extend the existing uptrend.

The upside surprise in CPI inflation last week unleashed a new wave of USD bullish momentum and eventually took the DXY dollar index to a fresh cycle high, touching the 105.00 level. A risk-off episode in global stock markets additionally helped to fuel USD strength, especially vs the risk-sensitive currencies (AUD, NZD, CAD). Interestingly, other safe-havens like the yen also benefited, which was an outperformer on this risk aversion episode after a prolonged period of weakness (more in the JPY section below).

We are entering a quiet period on the economic calendar following a busy previous week. The dollar retained strong levels, though it experienced a short-term correction after the Fed meeting on what seemed like a “buy the rumor sell the fact” behavior. The markets were already positioned for a very hawkish Fed, which Powell and company delivered, but Powell’s comment that an even larger 75bp hike is off the table for now was a reason for some profit-taking that triggered a retracement.

The opening week of a new month usually comes with a busy economic calendar, and this one is no different. The main highlights in the US are the Fed meeting on Wednesday and the Nonfarm Payrolls report on Friday. The longer-term trend, which is the divergence between the hawkish Fed and other central banks that are either less hawkish or outright dovish (e.g., BOJ), will likely keep the dollar strong during this and in the coming weeks. Aside from the hawkish Fed supporting it, another reason for the strong dollar is the weakness in other currencies (more about this in the sections below).

The past and this week are a quiet period ahead of the busy first week of May that features, among else, the Fed meeting and the Nonfarm payrolls report. Thus, without anything that can alter the longer-term Fx drivers, the markets’ focus is fixated on the divergence between the hawkish Fed and other central banks that are either less hawkish or outright dovish (e.g., BOJ). This policy divergence is and will likely continue to push the dollar higher in the coming weeks.

The dollar is extending the rally as the policy gap between the Fed and other central banks continues to widen. US Treasury yields climbed further, and over the Easter break, Fed speakers kept talking about fast QT and 50bp rate hikes. The most hawkish voice at the Fed, St. Louis Fed President James Bullard (voter this year), even talked about the possibility for even larger, 75bp rate hikes. He wants to swiftly raise rates to 3.5%, which in his view will effectively curb inflationary pressures. Few other central banks are in the same position, and this divergence should continue to underpin the USD dollar during this and the following weeks.

The dollar is pressing on the new highs for the cycle after breaking out of the 1-month range last week. Renewed hawkish rhetoric from the Fed, this time for faster quantitative tightening (QT), pushed the greenback higher. Fed Governor Lael Brainard firstly spoke in favor of a speedier and larger QT process than previously thought, but the same vibe was also evident in the Fed meeting minutes released Wednesday, where FOMC members discussed an “expeditious” tightening of monetary policy at their latest meeting in March. All of this is consistent with further US dollar strength going forward, albeit the trend of moderate but relatively steady gains may continue. The fact that other central banks also need to tighten policy because of rising inflation acts as a counterforce that moderates the USD’s gains. However, the hawkish Fed, coupled with a strong US economy in contrast to others and a general risk-averse mood in markets (amid the war in Ukraine and else), should continue to support the US dollar in the foreseeable future.

Some may find it strange that the euro is falling now that there has been some withdrawal of Russian troops on the ground in Ukraine (supposed military de-escalation). However, this all goes back to what we have discussed here in the past 4-5 weeks, which is that as long sanctions remain in place, the euro will hardly be able to sustain any material gains. With the sanctions likely to remain in place (potentially permanently or as long as Putin is President), the immediate economic outlook for the Eurozone remains rather grim.

Perhaps the technicals best highlight the significant crossroad that the EURUSD pair has reached. the most important event is the appearance of a bullish harmonic bat pattern (see chart below). As you may already know, harmonic patterns are known to either work beautifully or fail miserably. In the case of EURUSD below, the bat pattern is currently in progress. It has bounced off the harmonic support zone but has not progressed higher toward its 38.2% Fib retracement yet (at 1.1380). Reaching this level is a minimum requirement for the pattern to be deemed successful.