USD to reverse sharply amid correction in stock market; investors likely to open short positions

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The greenback faced strong selling pressure after the release of a worse-than-expected US employment report for April on Friday. The US dollar index fell to 90.20, reaching its lowest level since the end of February.

Meanwhile, riskier assets have gained momentum on the back of moderate economic growth prospects and the high likelihood that the Fed will keep cheap liquidity.

This allowed major US stock indexes to hit record highs at the end of last week.

However, on Monday, volatility crept back to the market due to fears of growing inflation and talk about the possible reduction of stimulus measures before the economy fully recovers.

At the end of yesterday's trading, the S&P 500 index fell by 1%, the Dow Jones sank by 0.1%, and the Nasdaq Composite dropped by 2.6%.

The weak NFP report assured investors that the Fed would leave interest rates below zero for a long time, but the "hawkish" comments of the president of the Federal Reserve Bank of Dallas, Robert Kaplan, forced market players to change their minds.

"The US labor market should continue to make a strong recovery despite its weaker-than-expected performance last month because consumer demand remains robust," Robert Kaplan stressed.

He also said that as the US economy gets closer to the Fed's goals. Therefore, it would be wise to start a discussion about curtailing bond purchases sooner rather than later as he sees the excesses and imbalances, as well as the negative consequences of some of these purchases. At the same time, Kaplan did not clarify when it may happen.

Investors are now waiting for the release of data on Wednesday, which is expected to show that inflation in the United States rose above the Fed's 2% target in April.

Although the Fed is constantly trying to convince market participants that any inflation caused by large-scale economic stimulus programs will be temporary, but prices for almost everything from raw materials to real estate are soaring.

According to forecasts, last month, inflation in the United States increased to 3.6% in annual terms, compared with 2.6% recorded in March.

The greenback may gain short-term support if consumer prices unexpectedly exceed forecasts, analysts at Commerzbank pinpointed.

Currently, the US currency remains under bears' control and continues to fluctuate around the psychologically important level of 90.00. A break below will lead to a fall to the lows of February near 89.60. A deeper decrease may push the US dollar to the lows of the beginning of the year at 89.20.

"We can see the impact of the opposite factors: on the one hand, the rise in commodity prices raises the prices of commodity currencies. On the other hand, it increases inflationary pressure, which leads to the instability of risky assets," strategists at Bank of Singapore emphasized.

The main question is whether the Fed will be able to control the situation if inflation rises more strongly than expected. It is not yet clear what actions the Fed may take.

The greenback may jump amid concerns about rising inflation but its rally will be short-lived according to Societe Generale.

"The correction of the US stock market amid concerns about accelerating inflation will lead to the long-term dilemma of the Fed on how to control inflation and support the economy," the bank's experts said.

The intention to speed up the economy is good but the US stock market may fall due to the fears about rising inflation. Investors might be scared by the difference between economic growth and inflation. Therefore, even a sharp correction of the stock market which will provide a short and possibly a sharp jump in USD will be a signal to sell off the US currency.

The material has been provided by InstaForex Company - www.instaforex.com

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