EUR/USD outlook in spotlight as attention turns to FOMC

The EUR/USD was trading modestly higher this morning before turning a tad lower. But I don’t expect it to move too much further until the Fed’s rate decision, which is set for Wednesday. While we have just seen a slightly stronger headline US retail sales print and a few other second-tier US data are due before the FOMC decision, these are unlikely to trigger any major moves. That’s because markets remain quite uncertain over the size of the forthcoming rate cut and the remaining data releases won’t have much influence on that decision. In so far as that EUR/USD outlook is concerned, a lot will depend on the pace of the future ECB vs. Fed rate cuts. The ECB might have started this race first, the Fed is likely to outpace it in the next few meetings. For that reason, the EUR/USD may be able to rise further in the weeks and months ahead, especially if Kamala Harris wins the US presidential election race.

What will the Fed decide?

Despite hotter inflation data last week, the focus has shifted toward economic growth and the slowing jobs market, which has prompted the Fed’s dovish pivot. With equal chances of a 25 or 50-bps cut, the US dollar has weakened. Investors will likely hold steady until Wednesday’s announcement, which could either confirm a smaller cut or hint at larger easing down the line, keeping the dollar under bearish pressure.

Indeed, markets remain quite uncertain over the size of the forthcoming rate cut. Just last week, the release of slightly stronger US core CPI and PPI inflation data left investors speculating about a dovish move. However, rates markets have since started to price in a 50-basis point cut instead of 25, with a 65% probability compared to around 35% last week. Should the US central bank opt for 25 basis point instead, this should come as a surprise to the market now and therefore trigger a dollar rally – even if it ultimately proves to be short-lived as the Fed Chair Powell could deliver a more dovish assessment of the economy and interest rates at his press conference. So, there is the potential for the EUR/USD to drift lower and move back below the 1.1100 handle, before potentially resuming higher.

Why is our EUR/USD outlook slightly bullish

With a struggling Chinese economy, which is not great for Eurozone exports, and continued weakness in Eurozone data, we can’t be too bullish on the euro at this stage. However, uncertainty over inflation means the EUR/USD outlook is not necessarily bearish. The Fed is seen cutting rates faster than the ECB over the next several meetings, which should narrow the yield differential between US and Eurozone bonds, and in doing so keep the EUR/USD supported. Therefore, my slightly bullish EUR/USD outlook is more a function of falling US interest rates and the dollar than necessarily being bullish on the euro itself.

Pace of ECB’s rate cuts may be slower than expected

The ECB followed through with an expected 25 basis point rate cut last week. President Christine Lagarde's calm and predictable communication style dominated at the ECB press conference, as she emphasised data dependency and kept forward guidance minimal, hinting at future cuts. But this leaves the door wide open as to what they will do in the remaining meetings of this year. With a struggling Chinese economy, the Eurozone is unlikely to show any solid performance in these last few months of the year. Here, inflation remains a bit sticky because of the stronger wage growth in the services sector. While we are unlikely to see the same levels of inflation as last year, the ECB will probably not cut rates too hastily this time. That’s what Governing Council member Martins Kazaksthough hinted at, due to lingering inflation risks. ECB President Christine Lagarde hinted on Friday that the next rate reduction is likely in December. Thus, if the pace of ECB’s rate cuts proves slower than the market is pricing, this should keep the euro in an overall bullish trend, providing a modestly bullish EUR/USD outlook.

EUR/USD technical analysis

Source: TradingView.com

The EUR/USD chart has been holding inside a 200-pip range since the middle of August, between 1.10 and 1.12. For as long as the lower end of this range holds, the short-term technical EUR/USD outlook will remain bullish. Indeed, the underlying trend is positive given the upward-sloping 21- and 200-day moving averages, the higher lows etc.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R