After a turbulent past week, calm has finally returned to the markets. Demand for risk assets slowly recovers: European indices have been rising for the third day in a row, US futures rebounded by more than 1.5% on Tuesday. The dollar index (DXY) fell against the euro and the pound, rose against commodity currencies amid falling oil, and gained significantly against the Japanese yen on worries that BoJ can’t handle situation in the JGB market. The Fed appeared to be unconvincing last week with a 75bp rate hike as US debt market yields continue to rise. The yield on 10-year US bonds rose from 3.19% to 3.29% since last Friday:

Optimism in the markets looks like an appropriate reaction to Biden's announcement that he is considering temporarily abolishing the federal fuel tax. However, this initiative must be approved by Congress, which will not be easy because the Republicans want the situation with high gas prices to cause maximum damage to the reputation of the US president and the Democratic Party. If the tax holiday can be passed through Congress, then on the monetary policy front, we may see more confident action from the central bank. In this case, we can expect a higher investment demand for the dollar. In general, the fiscal policy factor, which has receded into the background after the post-COVID stimulus, may again begin to play a significant role in the pricing of the dollar.

The main events of the economic calendar today will be the release of statistics on existing US homes sales, as well as the speech of Fed policymakers Tom Barkin and Loretta Mester. Home sales are expected to slow down again, but investors are likely to be reluctant to see this as a signal to lower interest rates, having already been burned their fingers last month when they tried to price in "September pause" in the Fed tightening. The next important event for the dollar and for the bond market will be Powell's testimonial in the Senate on Wednesday, which, judging by the latest Fed meeting, will also be hawkish, and therefore the dollar downside will most likely be limited.

The EURUSD consolidates around 1.055 searching for a new catalyst. News that the ECB has developed a new anti-fragmentation tool for the bond market seems to have been able to reassure investors as the yields of EU peripheral bonds turned into decline. The spread between the yields of 10-year Italian and German bonds, the main indicator of credit risk in the EU debt market, fell to 199 basis points from 242 bp last week:

In the run-up to Powell testimonial, EURUSD will likely remain in the range of 1.05-1.06, however barring any ultra-hawkish hints, the dollar can be “sold on the facts” causing EURUSD to retest or even break 1.06. However, given that stagflation risks persist and are higher for energy import-dependent EU countries, a break above 1.06 could be a good opportunity to short the pair: