Forex Analysis & Reviews: 25.01.2023 - Dollar finds it hard to...

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25.01.2023 11:47 PM

Dollar finds it hard to breathe

Over the past three months, the single currency has strengthened against the U.S. dollar by 11%. From its cyclical low in September, the EURUSD pair jumped by 14%. What is the reason for such an impressive spurt? At first glance, it's quite simple. US macro data usually disappointed traders instead of pleasing them. On the other hand, the eurozone often delivered pleasant surprises. It managed to avoid a crisis and investors are now laying down expectations for a recession in the U.S. economy. However, trust in central banks also plays an important role in developing an uptrend.

Trust is hard to earn, but easy to lose. No matter how much the Federal Reserve talks about keeping the federal funds rate at its peak in 2023, investors continue to believe in a dovish pivot. That the cost of borrowing in the U.S. will rise to 5% by mid-year, but fall by 50 bps at the end of the year. Conversely, people hardly talk about the European Central Bank doing the same thing. On the contrary, the market believes in a 50 bps hike at each of the two upcoming Governing Council meetings, in February and March.

Eurozone GDP forecasts

Trust is not based on previous mistakes by central banks, but on a change in the state of their economies. When the eurozone was fuming and the supposedly impending energy crisis painted a bleak outlook for its GDP, the ECB did not think about aggressively tightening monetary policy. Today everything has turned upside down. Bloomberg experts don't forecast recession in the currency bloc. In their view, the combination of surprising stability and a smaller decline in real income makes a deep recession much less likely than it looked in October.

Growing optimism can also be seen in the German government. It sees German GDP growth of 0.2% by the end of 2023, although in mid-autumn it predicted a 0.4% contraction. At that, officials expect a slowdown of inflation from 7.9% to 6%. The figure is quite decent, allowing the ECB to continue the cycle of monetary tightening. This circumstance creates a tailwind for EURUSD, while the Fed is finishing it.

German GDP dynamics

Judging by the opening of China and the improvement in European business activity, the situation in the bloc will continue to improve. At the same time, weak data on industrial production, retail sales, real estate market as well as a slowdown in inflation in the US hint at an approaching recession. Divergence in economic growth will continue to play into the euro's favor. At the same time the risks of a short-term correction have not been canceled. Deterioration of U.S. corporate profits or escalation of the armed conflict in Ukraine are among them.

Technically, much will depend on the pair's ability to leave the fair value range of 1.063-1.88. If the bulls fail to take the pair beyond its upper limit, the probability of a pullback to 1.082 and 1.078 will increase.

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*Disclaimer: The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade.