EUR/USD Outlook: Can Hot CPI Sustain the Stretched US Dollar Rally?

The US dollar rally is showing signs of exhaustion ahead of US CPI, despite expectations for a sharp rise in inflation. With EUR/USD oversold, bearish momentum fading and higher inflation potentially priced in, even a modest CPI disappointment could trigger a dollar pullback and provide the euro with some relief.

View related analysis:

EUR/USD Eyes Rebound as US Dollar Rally Faces an Inflation Test

US inflation data drops in a few hours, and it could help set the tone for Kevin Warsh’s comments at his fireside chat on Friday. It is no secret that crude oil prices are likely to see inflation heat up, given they rallied as much as 60% from the July low to September high, and are now curling higher once more and heading towards $100.

Naturally, this has prompted consensus forecasts to rise to 0.6% in September, or 2.5% annualised. For perspective, that would be the third-highest monthly print in four years and the second-highest annual rate in three.

US Dollar Faces Pullback Risk as Inflation Expectations Look Priced In

But we know that energy prices are likely to be a major driver. Therefore, the two questions are how broad-based the inflationary pressures are, and whether higher inflation expectations have already been priced in?

We can see that Brent crude prices have accelerated, making them a useful leading indicator of energy-related inflation pressures. We’ve already heard the RBA express concern that inflation could become more broadly based than just energy, and if such evidence shows up in today's US figures, it will likely exacerbate those concerns for central banks in general. Moreover, it could revive hawkish Fed bets.

That said, I have a hunch we’re not going to see that just yet. Core inflation has been relatively contained, while shelter inflation continues to ease. And that leaves today’s CPI with the potential to dent the USD, despite consensus forecasts having risen.

US Dollar Rally Looks Stretched Ahead of CPI

The US dollar index has rallied just under 4% over the past five weeks, and price action suggests trend exhaustion could be kicking in around major resistance levels. With traders already expecting higher inflation, there’s a decent chance it is already priced in – and anything less than expected, even if only marginally, could prompt a pullback in the dollar.

US Dollar Index (DXY) weekly and daily charts showing resistance near 102, bearish RSI divergences and slowing bullish momentum ahead of US CPI.

Source: ICE, TradingView

EUR/USD and USD/CAD Implied Volatility Spikes Ahead of US CPI

Looking across FX majors shows that 1-day implied volatility has spiked for USD/CAD and EUR/USD. I outlined a near-term bearish case for USD/CAD in an earlier report, based on its extended rally, pause around resistance levels and bearish engulfing candle on Tuesday. Its 1-day IV is 84 pips, which is 167% of its 20-day average.

Yet EUR/USD has gone a step further with a 1-day IV of 90 pips, or 237% of its own 20-day average. Expected levels of volatility are also elevated on USD/CHF, GBP/USD, AUD/USD and NZD/USD, though only marginally above their own 20-day averages.

EUR/USD Technical Analysis: Euro vs US Dollar

If the US dollar rally appears stretched, there is a reasonable chance the EUR/USD rally could be oversold – given the euro accounts for nearly 60% of the DXY weighing. The weekly chart shows that its 4-week decline is losing bearish momentum with diminishing high-to-low ranges (bottom indicator). The weekly RSI (2) has been oversold for several weeks and now trying to curl higher, while a bullish divergence has formed on the daily RSI’s. Moreover, the 50-day detrended price oscillator (DPO – bottom indicator) is near levels previously associated with trend reversals. This is not an exact science as such indicator provide ‘indications’ and not signals as such. But put together, bears may at least want to tread with caution.

Also take note of Tuesday’s bullish engulfing candle. With a hunch that a hot CPI is priced in and high crude oil prices might not be showing up much beyond energy, my bias is for a bounce on EUR/USD while prices hold above the recent swing low.

Source: ICE, TradingView

From time to time, StoneX Financial Pty Ltd (“we”, “our”) website may contain links to other sites and/or resources provided by third parties. These links and/or resources are provided for your information only and we have no control over the contents of those materials, and in no way endorse their content. Any analysis, opinion, commentary or research-based material on our website is for information and educational purposes only and is not, in any circumstances, intended to be an offer, recommendation or solicitation to buy or sell. You should always seek independent advice as to your suitability to speculate in any related markets and your ability to assume the associated risks, if you are at all unsure. No representation or warranty is made, express or implied, that the materials on our website are complete or accurate. We are not under any obligation to update any such material.

As such, we (and/or our associated companies) will not be responsible or liable for any loss or damage incurred by you or any third party arising out of, or in connection with, any use of the information on our website (other than with regards to any duty or liability that we are unable to limit or exclude by law or under the applicable regulatory system) and any such liability is hereby expressly disclaimed.

FOREX.com is a trading name of StoneX Financial Pty Ltd.

The material provided herein is general in nature and does not take into account your objectives, financial situation or needs.

While every care has been taken in preparing this material, we do not provide any representation or warranty (express or implied) with respect to its completeness or accuracy. This is not an invitation or an offer to invest nor is it a recommendation to buy or sell investments.

StoneX recommends you to seek independent financial and legal advice before making any financial investment decision. Trading CFDs and FX on margin carries a higher level of risk, and may not be suitable for all investors. The possibility exists that you could lose more than your initial investment and CFD investors do not own or have any rights to the underlying assets.

It is important you consider our Financial Services Guide and Product Disclosure Statement (PDS) available at www.forex.com/en-au/terms-and-policies/, before deciding to acquire or hold our products. As a part of our market risk management, we may take the opposite side of your trade. Our Target Market Determination (TMD) is also available at www.forex.com/en-au/terms-and-policies/.

StoneX Financial Pty Ltd, Suite 42.01, 264 George Street, Sydney, NSW 2000 (ACN 141 774 727, AFSL 345646) is the CFD issuer and our products are traded off exchange.

Delayed London Stock Exchange (LSE) Data

The London Stock Exchange (LSE) market data displayed or referenced on this website is provided on a delayed basis and is not in real time. The delay period may vary but is typically at least 15 minutes. This data is intended for information purposes only and should not be relied upon for trading, investment, or other financial decisions. We do not guarantee the completeness, reliability, or suitability of the data for any particular purpose. Users should consult real-time data sources and obtain professional advice before making any financial decisions.