After an unprecedented period of US dollar strength and risk aversion mood, markets appear to have taken a breather this week.
Since the end of the second quarter, the US dollar index has jumped nearly 3% and is currently consolidating above 107 levels.
The underlying issues that are fueling the recent dollar rally have remained unchanged and this week’s moves can be seen as a short-term relief rally.
The theme of higher-than-expected inflation continues after last week’s US Consumer Price Index – the critical measure of inflationary conditions in the United States – turned higher than expected to a high of 40 9.1% vs. previous reading of 8.6%.
That sparked further dollar buying in anticipation of a more hawkish US Federal Reserve, which will meet again on July 27 (10 p.m. UAE time) to decide on its next interest rate hike in the US. purpose of curbing the rise in inflation.
Markets were anticipating a 1% rise at the Fed meeting.
But, after comments from Atlanta Fed Chairman Raphael Bostic and St. Louis Chairman James Bullard that moving interest rates too far “could undermine the positive trends still seen in the economy and add to already significant uncertainties,” markets are now pricing in a 75 basis point increase.
The move would follow the Fed’s 75 basis point hike last month.
Economic data in the United States shows signs of improvement, despite inflation that is close to peaking.
U.S. retail sales released last Friday showed a 1% month-over-month increase in June, further indicating signs that the current rate hike compression and rising consumer prices are not as detrimental to retail spending as initially thought.
This led major US exchanges to recover some of the losses from previous weeks to close on a positive note on Friday.
Meanwhile, earnings season is expected to continue this week.
After a mixed run of banking heavyweights, Tesla, Johnson & Johnson, ASML and Netflix are all set to report results this week.
Keep an eye out for earnings-per-share announcements and revenue developments for these ultra-large-cap companies in the second quarter.
Any missed expectations on the downside for earnings could further undermine investor confidence in the near term.
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The announcement of the European Central Bank’s policy on interest rates is also scheduled for this Thursday (4 p.m. UAE time).
Markets are strongly pricing in a 25 basis point hike, which would be the ECB’s first interest rate hike since 2011.
The eurozone is battling higher-than-expected inflation, but stands in stark contrast to its counterparts in the US and UK, where the rate hike cycle has already begun.
The interest rate differential has therefore increased the pressure on the euro.
This month EUR/USD is down more than 3% at the time of writing and for the first time in 20 years the currency pair is trading at parity.
The pair’s reversal was quick and sharp and as EUR/USD now finds consolidation above the 1.01 levels, this pair level continues to remain a vital psychological support level.
If we see an accommodating ECB over the next few months, the parity level could be tested much more strongly before the end of the summer.
Meanwhile, gold – normally a hedge against rising inflation – had fallen to $1,716 at the time of writing.
Recent dollar strength has kept gold bulls in check and I expect the precious metal to continue trading with a slight bearish bias.
The channel between $1665 and $1680 remains a vital short-term support level and initiating long positions here could prove to be the most productive strategy. However, the upsides will be capped at $1,745 throughout July.
Other crucial data points to watch on the economic calendar this month include US home sales, due out July 26, and US gross domestic printing on July 28. GDP is expected to reach 1% quarter-on-quarter. , down from a previous reading of minus 1.6%.
Gaurav Kashyap is a risk manager at Equiti Securities Currencies Brokers. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti Securities Currencies Brokers
Updated: July 20, 2022, 04:00