The dollar bounced back yesterday and showed decent gain against commodity currencies, which correlate with demand for risk. This comes after the ECB issued a very aggressive statement yesterday. The reaction of the currency market turned out to be unusual – investors regarded the ECB’s move as an increased risk that a soft landing of the EU economy would not happen, so they decided to buy the dollar, where the yield on overnight deposits is already 4.35%. 

The result of the meetings of the ECB and the Fed was the strengthening of inversion of the yield curve – short-term bond rates rose relative to long-term even higher:

Concerns about a slowdown in global growth remain prevalent, and it looks like a bad environment for equities and commodities.

In terms of global demand, reports indicate that China’s abandonment of its zero-Covid policy is making the epidemic less and less controllable. Those who have been betting on the momentum of China’s economic reopening and a mini-expansion phase in 2023 may soon begin to dial back bets on that outcome.

The dollar index appears to have set some sort of low around 103.50 on Wednesday and that this week’s repricing of global growth could provide some support to safe-heaven, high yielding dollar next week. If the dollar remains at current levels until January, when seasonal trends become more favorable, the chances for a new dollar rally should be high.

The price for the ECB’s soft 50 basis point rate hike yesterday was much greater determination to continue raising rates going forward. It’s rare that central banks want to tell the market that it’s misjudging the central bank’s plans, but that’s exactly what ECB President Christine Lagarde did yesterday. The two-year euro swap rates rose by 25-30 basis points, and the EUR/USD initially jumped to 1.0735. However, as European and global equity markets began to bear the brunt of this hawkish shift, EUR/USD fell sharply yesterday.

Despite the position of the ECB, a bearish scenario for EUR/USD in the New Year looks more likely, due to the fact that the dollar will begin to play the role of a protective asset in the face of increased recession risks. In today’s economic calendar, PMI data for December is interesting. It is very likely that they will all remain in recession territory. We will also see the Eurozone trade balance for October, which is expected to bounce back from a €37bn deficit the previous month. As long as the EUR/USD continues to trade and closes above 1.0600/10, it’s hard to say with certainty that the pair’s rally is over in the short term. However, in case of a breakout, the EURUSD short-term recovery trend will be broken and the pair will probably go flat, drifting towards 1.05: