The dollar strengthens, AUD and EUR lose ground

The foreign exchange market is gradually entering a new phase of monetary policy re-evaluation. While a few months ago investors were confident in the Fed's rapid transition to an easing cycle, the market is now increasingly pricing in a "higher for longer" scenario, and some participants are even admitting the risk of new rate hikes in the US.

Against this backdrop, the US dollar is beginning to receive broad fundamental support, while currencies with weaker economic backgrounds – primarily the Australian dollar and the euro – are coming under increasing pressure.

USD: Market begins to believe in tighter Fed policy

The key change in recent weeks has been the gradual transformation of the Federal Reserve's rhetoric. Fed officials are increasingly talking not about future rate cuts, but about the need to "keep all options open."

A particularly important factor remains the resilience of the American economy. Despite tight financial conditions, the labor market continues to look stable, and inflationary pressure is not showing sufficient slowdown.

An additional risk for the market is created by the situation around Iran and the Strait of Hormuz. If tensions in the Middle East persist and oil prices remain high, this could again intensify inflationary pressure in the US. In such a scenario, it will be increasingly difficult for the Fed to justify policy easing.

Markets are already beginning to price in the probability of a new rate hike by the end of the year. That is why any speeches by Fed officials, especially Christopher Waller, are now perceived as a potential catalyst for a new dollar strengthening.

AUD: Australian dollar loses one of its main advantages

AUD/USD is increasingly looking like a pair forming a medium-term peak.

Recently, the Australian dollar received support due to the aggressive stance of the Reserve Bank of Australia. However, the situation is now beginning to change. After the last rate hike to 4.35%, the RBA's rhetoric has become much more cautious.

A split is already noticeable within the central bank itself: one member voted to keep the rate unchanged, and comments from RBA representatives increasingly indicate a desire to pause and assess the consequences of previous tightening.

At the same time, Australia's economic data is starting to deteriorate. Unemployment unexpectedly rose to 4.5% – the highest since 2021. Flash PMIs also showed a noticeable slowdown in business activity.

The market has virtually stopped believing in a further aggressive cycle of rate hikes in Australia. This is what creates a dangerous fundamental divergence:

• The Fed is moving in a tighter direction,
• The RBA, on the contrary, is gradually moving towards a pause.

In such conditions, AUD/USD may remain under pressure in the coming months, especially if the dollar continues to receive support from strong US data and high oil prices.

EUR: Euro faces risk of new bearish phase

EUR/USD also starts to look increasingly weaker after falling below 1.16.

Initially, the market believed that the energy shock would force the ECB to act more aggressively and support the euro through tighter monetary policy. But now attention is shifting to another problem – the weakness of economic activity in the Eurozone.

The latest PMIs indicate a noticeable cooling of the economy. This is especially important as Europe simultaneously faces:

• weak economic growth,
• high energy prices,
• and still elevated inflation.

In fact, the market is beginning to fear a stagflationary scenario.

Although an ECB rate hike in June is almost guaranteed, investors are increasingly less confident in the possibility of aggressive tightening after the summer. While a few weeks ago the market expected almost 85 basis points of hikes by the end of the year, these expectations have now significantly decreased.

Against this backdrop, the yield differential between the US and Europe is once again beginning to move in favor of the dollar.

ING analysts believe that EUR/USD could be entering a new bearish phase with potential to move below 1.1500, especially if:

• The Fed continues to harden its rhetoric,
• European data remain weak,
• and the energy factor continues to put pressure on the Eurozone economy.

CHF: Franc remains a safe-haven currency

The Swiss franc continues to look relatively stable amid general uncertainty.

The Swiss National Bank is not yet showing a desire to actively change policy. Although the market has partially started to price in the possibility of tightening due to the energy shock, the SNB will likely remain very cautious.

An important factor is the structure of the Swiss economy. It is significantly less dependent on fossil fuels compared to most European countries, which allows Switzerland to appear more stable in conditions of high energy prices.

Because of this, EUR/CHF is now largely dependent on the prospects for the euro and the ECB's policy. If economic weakness in the Eurozone continues, the franc may remain a strong safe-haven asset.

The FX market is gradually shifting from the topic of future rate cuts to the topic of inflation and the risk of a longer period of tight monetary policy.

This is what is currently forming the basis for a broader recovery of the US dollar.

The most vulnerable in this context appear to be:

• AUD – due to the weakness of the domestic economy and the change in RBA rhetoric,
• EUR – due to the risk of stagflation and deteriorating economic activity.

In contrast, USD is receiving support from:

• the resilient US economy,
• tighter Fed rhetoric,
• and the risks of a new inflationary impulse from the oil market.

The coming weeks could be critical in determining whether the current strengthening of the dollar turns out to be merely a correction or the beginning of a new medium-term bullish trend for USD.