EUR/USD analysis: Euro falls to key support as markets react to BOJ ahead of FOMC

• EUR/USD analysis: What to expect from the Fed?
• Widening rates differential undermines euro despite hawkish ECB rhetoric, ZEW survey
• EUR/USD technical analysis - price is testing key 200-day average

The biggest moves in FX took place overnight as the first of the two major central bank decisions this week sent their currencies sharply lower. First up it was the Reserve Bank of Australia opting to make a slight dovish tweak in its hawkish guidance after keeping rates unchanged at 4.35% as expected. Then it was the big one: The Bank of Japan finally delivered a 10-basis point rate hike, its first hike since 2007, to end the zero-interest rate policy. The BoJ also abandoned its yield curve control (YCC) and ETF purchases policies but maintained bonds purchases. It had a “dovish hike” written all over it and the yen slumped across the board, most notably against the US dollar, as the yield differential between Japan and the rest of the world increased. Given the recent inflation prints in the US, it was hardly surprising to see the greenback being the strongest currency at the start of the European session. This meant that the EUR/USD would start the day weaker. But can the EUR/USD rebound from here, as the focus turns to the Fed?

Widening rates differential undermines euro despite hawkish ECB rhetoric, ZEW survey

The fact that the EUR/USD has weakened has a lot to do with bond yields moving in the favour of the dollar following the BOJ rate hike, than it has anything to do with the euro. Indeed, we have heard today from the European Central Bank's Luis de Guindos, who said the ECB needs to wait for June before deciding on a rate cut, which is not exactly dovish. We also had better German ZEW numbers today which should limit the downside.

The only the only piece of data we had from the eurozone today was the German ZEW economic sentiment survey which came in better than expected at 31.7 versus 20.6 expected, rising from 19.9 previously. The eurozone ZEW economic sentiment survey also beat expectations, coming in at 33.5 versus 25.4 expected and rising from 25.0 previously.

EUR/USD analysis: What to expect from the Fed?

The market's focus is now turning to the FOMC meeting on Wednesday. The Fed is expected to keep interest rates unchanged at 5.50%, but it's not the rates decision that the FX markets are worried about. It is forward guidance. Will the Fed still keep three rate cuts in its dot plots, or will it opt for two rate cuts for 2024 instead? That's the key question.

Judging by the recent dollar strength you have to say that the market is expecting the Fed to deliver a hawkish surprise in its dot plots i.e., pointing to fewer than the 3 rate cuts in 2024 that it had projected previously. But this outcome is already priced in, with the market now pricing just 68bp of Fed cuts this year. If the FOMC’s dots shifts to 50bp of cuts this year, then there is potentially some room for modest further USD strength. The Fed will need to be quite hawkish to keep the dollar pressing higher at these lofty levels, which is an unlikely event in my view.

Instead, if the median forecast remains at three or somehow rises to more than 3, then this would come as a dovish surprise, and we could well see the dollar weaken across the board. On the back of this potential outcome, we could see gold head towards a new record high; the EUR/USD could rise towards 1.10 handle, while even the USD/JPY might start to fall back following its sharp gains today.

EUR/USD technical analysis

Source: TradingView.com

At the moment, there is no clear directional bias on the EUR/USD currency pair. That being said, rates have been going higher over the longer-term period starting from October of 2023 when it made a low at 1.0448. In order to maintain the bullish bias, the 200-day moving average needs to hold as support, which was being tested at the time of writing at 1.0835. This level is key support as far as the short term is concerned. The next level to watch is at 1.0795, which was the law from the end of February, the last low prior to the recent up move. Should 1.0795 break down on a daily closing basis, then the EUR/USD would start to look more appeasing to the bearish camp than the bulls.

That's a scenario that the bullish traders will not want to see, obviously. Instead, if rates hold around the 200-day moving average and start to rise above resistance at 1.0885 and close above this level either today or ideally tomorrow following the FOMC rate decision, then that would be a rather bullish outcome for this currency pair. In that scenario, we could then see rates go on to climb to an new high for the year above 1.10 handle and possibly head towards the December high of 1.1140 in subsequent days.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R