The EURUSD pair has reached multi-year highs due to economic factors, monetary policy, and risk appetite. However, the euro is facing challenges. Will the US dollar capitalize on these weaknesses? Let’s discuss this topic and make a trading plan.
The article covers the following subjects:
Highlights and key points
- The divergence in US and Eurozone economic growth is narrowing.
- The difference in the pace of monetary policy expansion between the Fed and the ECB is not as significant as it seems.
- Jerome Powell could dampen global risk appetite in Jackson Hole.
- A drop in the EURUSD pair below 1.11 may trigger a pullback.
Daily US dollar fundamental forecast
The combination of increased global risk appetite, narrowing divergence in the US and eurozone economic growth, and differing paces of monetary expansion by the Fed and the ECB has allowed the EURUSD pair to make a triumphant rally to almost 1.12. Bank of New York Mellon reports that money managers have been purchasing euros on a daily basis for the past two weeks. UBS has observed that algorithmic traders made significant sales of approximately $70-80 billion in August, with the eurozone currency emerging as a primary beneficiary. The question remains whether it will be able to maintain its gains.
The latest eurozone PMI data appears to have provided further impetus to the EURUSD rally. The eurozone composite purchasing managers’ index accelerated to a three-month high while its US counterpart slowed. This suggests a narrowing divergence in economic growth on paper. However, a closer examination reveals that the European PMI gains are likely linked to the Paris Olympics. Once the effect wears off, the indicators will revert to their previous levels.
Eurozone PMI
Source: Bloomberg.
The same is true for the varying paces of monetary expansion. In advance of the release of the minutes from the ECB’s June meeting, the futures market indicated a 40% likelihood of a 25 bp reduction in the deposit rate in September and projected the extent of monetary easing at 50 bp in 2024. In comparison to the 100 bp for the federal funds rate, this factor triggered the EURUSD rally. However, at the most recent meeting, the Governing Council observed that the early autumn period would be an optimal time to adjust monetary policy. As market expectations became less optimistic, the euro declined in value.
The ECB has expressed minimal concern regarding the sustainability of services inflation. However, inflation expectations in the eurozone are declining at a faster rate than in the US and the UK. This indicates that the ECB should adopt a more aggressive stance in reducing rates, particularly given the slowing of the average agreed wage in the currency bloc from 4.7% to 3.6% in the second quarter.
Inflation expectations in US, UK, and EU
Source: Financial Times.
The market is undervaluing the ECB’s determination while overestimating the capabilities of the Fed. The divergence in the pace of monetary expansion is not as pronounced as it initially appears. As soon as investors recognize this, the EURUSD pair will slump. Jerome Powell’s speech in Jackson Hole may serve as an indicator for selling the major currency pair. Investors have overly optimistic expectations of him. The US stock indices are growing at an accelerated rate, fueling global risk appetite. Is it time to temper these expectations?
Daily EURUSD trading plan
It seems that markets are preparing to sell the euro based on the facts. In this scenario, a decline in the EURUSD rate below 1.11 will generate a sell signal.
Price chart of EURUSD in real time mode
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