Could a single inflation report be enough to prompt the Fed to raise interest rates? The market appears to think so, largely overlooking Christine Lagarde’s hawkish rhetoric and the decline in US Treasury yields. Let’s examine the key factors driving the EUR/USD outlook and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- The ECB raised its rate to 2.5% but gave no signals.
- US producer prices rose to 5.4%.
- The probability of a Fed rate hike in September has risen to 72%.
- High inflation is a reason to increase short trades opened at 1.164.
Daily Fundamental Forecast for Dollar
Will the ECB raise interest rates in October? Following the Governing Council’s September meeting, the question remains open. However, the market appears more focused on whether the Fed could tighten monetary policy at its next meeting in response to a single inflation report. This would run counter to Kevin Warsh’s call for policymakers to avoid placing too much weight on any single data point. At the same time, the risks associated with allowing inflation to become entrenched may be considered more significant.
The ECB unanimously raised its deposit rate from 2.25% to 2.5%, but its accompanying statement emphasized a data-dependent approach. The Governing Council provided no forward guidance on a specific path for future interest-rate changes. Together with modest upward revisions to its inflation and GDP forecasts, this prompted a sell-off in the EUR/USD as markets shifted from earlier expectations to a more cautious assessment of the ECB’s policy outlook.
ECB Projections for Inflation and GDP
Source: Bloomberg.
Christine Lagarde’s hawkish rhetoric offered some support for the euro but did not dramatically change the broader policy outlook. The ECB President highlighted the resilience of the European economy, supported by solid PMI readings and investment in AI, suggesting that the economy may be able to withstand higher interest rates. At the same time, she pointed to the risk of renewed inflationary pressure as conflicts in the Middle East and Ukraine continue to drive up energy prices.
According to Bloomberg, members of the Governing Council are prepared to continue tightening but consider market expectations for three additional rate hikes too aggressive. The timing of any further move remains uncertain: it could come in October, but the ECB may instead wait until its December meeting, when updated economic forecasts will be available.
Pressure on the EUR/USD also came from a renewed acceleration in US producer-price growth, which rose 0.4% month over month and 5.4% year over year in July. The increase raised concerns that progress on inflation could be losing momentum. Against the backdrop of Kevin Warsh’s comments at Jackson Hole that he remained unconvinced by the slowdown in PCE inflation in June and July, markets increased the probability of a September Fed rate hike to 72%, providing additional support for the US dollar.
US Producer Price Index
Source: Wall Street Journal.
Investors will be watching the upcoming consumer price data closely. A renewed acceleration in inflation could strengthen expectations of a Fed rate hike within the next week, providing additional support for the US dollar.
The rise in Treasury yields has a more mixed impact on the EUR/USD. On the one hand, higher yields can increase the appeal of US assets, while the Treasury’s challenges in executing buybacks may help reinforce confidence in the dollar. On the other hand, rising yields could also reflect capital flows from the US toward Japan, which could weigh on the US dollar index.
Daily Trading Plan for EUR/USD
Markets are awaiting the upcoming US inflation data. Stronger-than-expected figures could create an opportunity to add to short positions in the EUR/USD established around 1.164. Weaker-than-expected data could trigger euro buying at market prices, while a broadly neutral reading could lead to heightened volatility and two-way price action.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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