- The euro is expected to remain under pressure against the US dollar in the near term, but we anticipate volatility around the US inflation report on Wednesday and the European Central Bank's decision on Thursday.
- According to reliable trading platforms, the EUR/USD exchange rate recorded a 0.65% decline from peak to close on Friday amid a significant readjustment in US interest rate expectations following a strong US jobs report and speeches from influential members of the Federal Reserve's decision-making committee.
- Currently, the EUR/USD is trading around 1.1040 at the time of writing this analysis.
Generally, the market realized that the Federal Reserve is expected to cut US interest rates by 25 basis points in September, with the possibility of a 50-basis point cut before the end of the year becoming less likely. This is because all indicators suggest that the US economy is gradually slowing, but not fast enough to justify aggressive easing, which would be implied by a 50-basis point cut. These disappointed investors hoping for easy money from the Federal Reserve, which is reflected in weak stock markets and the strength of the "safe-haven" dollar. This adjustment may continue in the coming days, meaning that the euro's rise against the US dollar may have halted, and the decline could extend further.
However, there is some technical support at 1.1043, last week's low, which may halt the declines in the early parts of the week. However, there is still significant room for the price to fall below the 1.10 level, as all major moving averages are lower (with the 50-day moving average now at 1.0952).
So, technically, there is scope for continued weakness.
According to economic calendar results, the monthly US inflation data is scheduled to be released on Wednesday, and given the importance of global drivers, this could ultimately prove to be the highlight of the week for US dollar exchange rates. If US inflation comes in below expectations, market expectations of a 50 basis point US interest rate cut by the Federal Reserve on September 18 will increase, boosting stock markets and supporting the EUR/USD.
However, if the data comes in stronger, expect more selling pressure as the prospect of a 50bp cut is completely erased, in which case stocks could come under further pressure and the US dollar could rally.
Last week, we heard from two influential members of the US Federal Reserve’s interest rate-setting committee that while interest rate cuts are necessary, the path forward remains data-dependent. Concurrently, Financial markets are reading this as a signal that the US Federal Reserve is not worried enough to follow through with 50bp cuts and will prefer to stick with more traditional 25bp increases.
Obviously, this view could shift further if inflation figures exceed expectations and increasing the likelihood of another strong week for the US dollar.
On Thursday, the European Central Bank's decision is due, and it is widely expected that the market will see a rate cut. What is less certain is whether the ECB will cut rates again in October. Therefore, the updated guidance will be more significant for the market than the rate cut itself. Despite the slowdown in wage growth, it is still far above the ECB’s 2% target rate, and there is concern that wage growth may rebound in the third quarter, especially in Germany. As a result, while we expect a rate cut on Thursday, the ECB may not provide further guidance, instead stating that future decisions will remain data-dependent for the rest of the year.
Meanwhile, the chances of a rate cut in October had declined last week after a number of board members expressed their views on the matter. Accordingly, a note from forex analysts at HSBC states: "The latest ECB rhetoric suggests a significant hurdle to a follow-on cut in October after a likely easing in September." added, "The ECB is set to continue its quarterly easing with a 25-basis point rate cut in September. We expect communication to remain cautious and non-committal, with no change in the official language. We believe the October meeting will be 'live', but the path of least resistance is to continue with quarterly cuts this year."
This is important for euro exchange rates as successive rate cuts are not fully "priced in", meaning that such an outcome would require less readjustment in eurozone bond yields and exchange rates. Nevertheless, a stop in October would support current levels of the single currency, all else being equal. HSBC Bank says, "Hawks, as expected, point to concerns about rising services inflation and wage growth." And German central bank president Joachim Nagel is one of those hawks, saying this week "We should not burst into premature cheers and pat ourselves on the back."
On the other hand, Gediminas Simkus argued that there are "compelling arguments for the ECB to cut rates in September", citing "structurally slow growth", "clear deflationary trends" and "downside risks" to the economy.
However, despite this dovish cocktail, he claimed that a rate cut in October is "unrealistic" as upcoming changes in economic forecasts are likely to be non-substantial. Currently, the market sees a 1 in 3 chance of a rate cut in October. Furthermore, if the chances of a rate cut in October rise in the coming days and weeks, we expect the euro to weaken. Moreover, given how small such an outcome is, we believe the euro can remain supported near current levels against the pound and the US dollar.
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EUR/USD Technical analysis and forecast:
As expected, the EUR/USD will remain in its current range until markets and investors react to the announcement of US inflation figures and European Central Bank policy. A break below the 1.1020 support will strengthen the bears' move down and the next major support levels will be 1.0945 and 1.0880 respectively, at which level the direction will turn bearish. Conversely, according to the daily chart performance, the resistance levels of 1.1150 and 1.1220 will be the most important for the bulls to regain control of the trend.
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