After the corrective rebound that took place at the end of May, risky assets, led by US stocks and the euro, went into consolidation mode at the reached levels in anticipation of important events that could significantly affect investor sentiment.
"We are still in a constant upward and downward movement due to the fact that we do not know what inflation will be, what economic growth will be, whether there will be a recession or not," Kleinwort Hambros strategists noted.On Tuesday, US Treasury Secretary Janet Yellen said she expects high inflation to continue.
Some experts believe that the growth rate of consumer prices has already peaked, but how quickly inflation will weaken remains unclear.
Other analysts warn that, perhaps, we are at the dawn of the era of increased inflation, when single-digit rates of price growth after attempts to stop them will return to double-digit growth, as it was in the period from the mid-60s to the 80s.
In such a scenario, the Federal Reserve may go for a more active tightening of monetary policy. This, in turn, will increase the cost of dollar funding, negatively affect corporate earnings, provoke a recession and cause an outflow of liquidity from the markets, which is negative for a wide range of risky assets.
So far, the US stock market is behaving as if high inflation is a thing of the past, BlackRock analysts say. At the same time, market expectations regarding the Fed's rate hike have recently become more moderate due to hopes for a slowdown in inflation, which triggered a rise in stocks from this year's lows and put an end to the dollar rally, they note.
However, the protective greenback, apparently, does not intend to concede leadership to risky assets, since the tone of the Fed's statements still remains tough and a series of interest rate hikes in the coming months cannot be avoided, which keeps the markets on edge.
The USD index is still close to the 20-year peak reached in mid-May.
According to BlackRock analysts, for the emergence of a steady rally of risky assets from the US central bank, really dovish statements will be required.
The next Fed meeting will be held next week. In addition to the verdict on monetary policy, the central bank will publish forecasts for the current year on the main macroeconomic indicators in the United States.
Recently, several statistical reports have indicated the possibility of a slowdown in economic growth in the United States. Thus, the index of business activity in the service sector from ISM in May fell to the lowest in 15 months, and sales of new buildings in the country fell at the fastest pace in nine years.
In this regard, some experts have begun to say that the Fed will probably have to slow down the pace of rate hikes, which will become a deterrent for the USD.
"The dollar forms a risk premium as a safe asset, which is high and is now being adjusted," Deutsche Bank strategists said.
Analysts at RBC Global Asset Management note that they have started selling USD, believing that the greenback will soon become cheaper. At the same time, they intend to resume long positions after the correction of the US currency, considering fears of a recession in the US as exaggerated.
This week, the dollar is struggling to attract bulls, while the euro is holding its positions, waiting for the European Central Bank's verdict on monetary policy.
"It should be difficult for the US dollar to achieve further growth against the euro at the moment, since it is probably possible to assume that the ECB will show a hawkish attitude at its next meeting. The greenback may get a new boost next week when the Fed's decision is due on Wednesday. But until then, the euro can set the pace," Commerzbank analysts noted.
On Thursday, the ECB is expected to announce the termination of the longest quantitative easing program, as well as give an idea of the likely future trajectory of interest rates.
Other leading central banks have already raised interest rates to contain surging prices.The ECB has lagged behind its colleagues in this regard, and any further delay in raising rates will cause an adrenaline rush in the inflation monster.
"The harmonized consumer price index in the eurozone is now 3% higher than before the last update of the ECB forecast. As a consequence, this may lead to the fact that ECB President Christine Lagarde will not completely rule out a more aggressive response than gradual steps by 25 bp. This should support the euro," CIBC Capital Markets analysts believe.
Currently, the EUR/USD pair does not abandon attempts to move as far as possible from the almost five-year lows reached in mid-May. However, the ECB head seems to need to outwit the market on Thursday so that the euro can maintain the momentum of recovery ahead of the next data on US inflation. The May CPI report in the US is also able to make significant adjustments to the dynamics of the EUR/USD pair, since a fresh signal from inflation will automatically affect market expectations for Fed rates.
"Given that ECB Chief economist Philip Lane last week unequivocally announced a 25bp rate hike in July and another in September, a hawkish surprise this week will probably require an open discussion of a 50bp rate hike by ECB President Christine Lagarde. Even in this scenario, market forecasts for a tightening of 118 bps by the end of the year mean that the opportunities for the euro to benefit from this are somewhat limited," ING strategists said.
A similar opinion is shared by TDS analysts.
"We expect the ECB to announce that the APP program will end in a few weeks, and also send a strong signal to the markets that rate hikes will occur in July and September. We believe that the ECB's updated forecasts will reflect stronger inflation and weaker economic growth, highlighting the challenges for the central bank in the future. Since the Euribor curve already reflects the most likely scenario of the ECB tightening, the opportunities for the EUR/USD pair to grow at this event remain limited," they said.
The main currency pair has been circling around the 1.0700 level since the beginning of the month.Much regarding the EUR/USD dynamics in the coming weeks will depend on the extent to which the ECB agrees with the recently increased market expectations regarding an increase in interest rates in the eurozone.
ECB President Christine Lagarde is unlikely to support the expectations of the markets on rates. The ECB's disappointing decision following the meeting on Thursday may pave the way for the fall of the main currency pair below 1.0600 over the coming week, Scotiabank believes.
"The markets almost completely put a 50 bps increase in prices at one of the ECB meetings in July or September. We believe that Lagarde is unlikely to add fuel to the expectations of a 50 bps rate hike, since the ECB adheres to the principle of a gradual approach in its communication policy," the bank's analysts noted.
"The disappointing ECB decision, US inflation and the Fed's hawkish stance next week could collectively push the euro below 1.0600 within a week," they added.
