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A strong labor market, retail sales, and high persistent inflation pushed both Treasuries yields and the U.S. Dollar up. The U.S. 10-year Treasuries yield broke through the 4% level for the first time since November 2022.

Suddenly, the upside yield movement was stopped by rising inflation in the Eurozone and a consequently possible higher than expected interest rate hike by the European Central Bank (ECB). Persistently high inflation in the United States, despite the Federal Reserve’s (Fed) hawkish monetary policy, along with strong economic performance is nudging the monetary watchdog to raise its rates above previous projections without any fears of an economic meltdown. FedWatch tool demonstrates interest rates are expected to hit a breath-taking 5.5% in June 2023 from the existing 4.75%. Bond yields are following elevated projections. Most importantly, the yield curve inversion between 2-year and 10-year Treasuries is narrowing, indicating lower chances for a recession. The gap between the yields is down to 0.81 percentage points in early March from 0.88 percentage points in the beginning of 2023. So, the Fed has its hands free to increase monetary tightening to bring inflation under control.

This should be undoubtedly positive for the Greenback to continue up soon. However, the U.S. Dollar index rolled back to 104.3 points from 105.3 points after unexpectedly declining by a marginal 0.1 percentage point to 8.5% year-on-year vs the estimated 8.2% in February. Inflation in Germany repeated its January levels at 8.7% year-on-year. Even more troubling is that core inflation, which does not include highly volatile food and energy prices, increased to 5.6% in February from 5.3% a month before. Could this mean that the ECB will have to raise interest rates above expectations? Could we be looking at 4.0% instead of consensus at 3.5%?

Such questions pushed EURUSD to 1.0670 from 1.0550, lowering the U.S. Dollar index to 104 points.

The ECB will hold its monetary decision meeting on March 16, ahead of the Fed that will meet on March 22. This has amplified the market’s reaction as the ECB may raise interest rates by the bold move of 0.5 percentage points instead of the expected 0.25 p.p., and above expected 0.25 p.p by the Fed. Nonetheless, the ECB may lose this race in a couple of months as it has less room to move interest rates higher. Europe has recorded its quarter GDP up by 0.1% vs 2.7% in the U.S. The unemployment level is at 6.7% and 3.4% respectively. Many European countries and corporates have immensely high debt burdens, which are weighing on the ECB’s decision. The damage done by high interest rates may outweigh any advantages of taming inflation.

It could be wise to consider that the U.S. Dollar index may continue to run within the 104.0-105.3 range, while the EURUSD may move between 1.0530 to 1.0700. Investors are expecting European GDP data to be released on March 8 and Non-Farm Payrolls data in the U.S. on March 10. This data will likely guide the money market before the ECB and Fed meetings.

The Greenback may resume to the upside within next months, gradually moving up to other currencies. The U.S. Dollar index has technical targets at 105.3 points, and the next target at 105.5-105.8 points.

Stock indexes are likely to lose in the battle of central bankers. Additional pressure from higher ECB interest rates will contribute to the Fed tightening efforts, making borrowings more expensive across the pond. This will push corporate margins lower and add more risks. Rising yields of safe haven government bonds may lead to capital outflow from risky stocks, hampering stock indexes. With this in mind, the S&P 500 broad market index may tumble to 3900 points, Nasdaq – to 10820 points once it crosses the 11625 points technical support.

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Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.