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16.05.2023 05:35 PM
EUR/USD correction gains momentum, dollar shows who's the boss in forex
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Why has the EUR/USD pair been growing for half a year? The U.S. dollar, after reaching a 20-year high in the fall of 2022, seemed overly expensive. The euro, with its unfulfilled recession in the Eurozone and the energy crisis fading into the background, on the contrary, seemed excessively cheap. The delay in the ECB's monetary tightening cycle compared to the Fed also played into the hands of the "bulls" in the main currency pair. But in May, the situation changed.

A slowdown in the inflation rate in the U.S. to a 2-year low allowed the market to loudly speculate about the Fed's dovish pivot, contrary to the statements of FOMC officials that the central bank intends to keep the federal funds rate at its peak for a long period. After strong labor market statistics in the U.S., the Fed finally listened. The odds of borrowing costs dropping in September fell from 90% to 62%, and the U.S. dollar became popular again.

U.S. inflation dynamics

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One of the reasons for the correction of EUR/USD was the expansion of the yield differential between U.S. and German bonds. Credit Agricole believes that this process will continue and calls the divergence in the rates of the two countries' debt markets one of the three reasons for the development of a correction in the main currency pair.

The second driver of the pullback is the difference in the quality of data coming from the U.S. and the Eurozone. The former is improving, while the latter, on the contrary, disappoints. This applies to disappointing data on industrial production in the Eurozone and ZEW economic sentiments in Germany. Danske Bank names the better dynamics of the U.S. economic surprise index compared to the European counterpart as one of the factors for the peak of EUR/USD to 1.06.

Finally, the third reason for the development of the euro correction, according to Credit Agricole, is the unwinding of overly inflated speculative longs in this currency. Indeed, until May, there were plenty of forecasts on Forex that by the end of 2021, EUR/USD would trade at the level of 1.16 and even 1.2. Using them, hedge funds actively bought the pair. However, as soon as it smelled like trouble, they began to get rid of long positions.

Even the U.S. retail sales data for April did not help the euro. The indicator grew by 0.4%, less than Bloomberg experts calculated. Nevertheless, the core indicator showed better dynamics than expected. As a result, after a slight increase, the main currency pair returned to its original positions.

U.S. retail sales dynamics

This image is no longer relevant

This image is no longer relevant

Thus, the American economy is stronger than expected. This makes the process of mass selling of the U.S. dollar impractical. Moreover, it is unclear how the currency will behave in case of default. Asset managers consider it the third best option for investing money after gold and Treasury bonds.

Technically, on the daily chart, the EUR/USD correction to the upward trend continues. The rebound from 1.089 allowed us to increase the shorts formed from 1.101. We continue to sell in case of updating local lows at 1.086 and 1.084.

Marek Petkovich,
Analytical expert of InstaForex
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