EUR/USD breakout shifts focus to payrolls, peace deals

• EUR/USD breaks long-running downtrend resistance
• Fed rate hike pricing pares back to 42bp by June 2027
• Lower energy prices improve euro area outlook
• Payrolls, peace negotiations to determine whether breakout has legs

EUR/USD has broken higher after spending much of this year trapped beneath downtrend resistance. Whether it sinks or swims will likely be determined by the incoming flow of US economic data and developments in the Gulf.

The stars align... for now

One of the key factors that's changed over the past week has been the US rate outlook. While the latest US data has generally continued to point to an economy that's performing strongly, traders have become less convinced about how much the Fed will need to tighten in order to combat inflation.

Both the ISM manufacturing and services PMIs outperformed expectations, while strength in the new orders components of both surveys points to the US economy continuing to chug along into the second half of the year.

Despite that, markets have pared back the amount of tightening priced by the June Fed meeting next year to around 42 basis points. Correlation analysis suggests EUR/USD has been tracking shifts in front-end US rates closely over the past week, helping to explain some of the move higher.

Source: TradingView

The other factor that's worked in the euro's favour has been the optimism that we'll eventually see some form of lasting peace deal in the Middle East. Whether that eventuates remains highly uncertain, but markets have responded by pushing energy prices lower once again.

That's important because Europe is a major net energy importer. Compared with the United States, which enjoys far greater energy security as the world's largest producer, lower oil and gas prices are a much bigger positive for the euro area economy. They reduce one of the key headwinds that has weighed on the common currency in recent months, easing the need for the ECB to respond aggressively to a supply-driven inflation shock that would otherwise have amplified the downside risks to economic activity.

Another factor that's probably helped the euro has been the intervention episode in Japan. It's highly unusual to see the US Treasury get involved in supporting another currency when we're not talking about a financial crisis or disorderly market conditions.

Why the US decided to get involved remains unclear. Whether it was about the yen, foreign demand for Treasuries, US FX competitiveness, or something else entirely, we simply don't know. What we do know is that it's put the US dollar on the back foot, providing a near-term tailwind for EUR/USD.

Clearly, the positives that have helped the euro not only come across as being very short-term factors, but there's also a lot of uncertainty as to whether they'll stick.

From a directional perspective for the euro, a lot of it will come down to the Gulf and Friday's US payrolls report, which really looms as the key factor given its ability to shift the Fed rate outlook.

EUR/USD breakout shifts focus higher

Source: TradingView

Turning to the charts, we saw a breakout from the minor downtrend that had been in place from the highs set back in the middle of July following last week's Fed meeting. That has since seen the pair extend the move, breaking above resistance at 1.1480 and the 50-day moving average to test the long-running downtrend that's been in place since late January.

After one false break on Monday that saw the pair retrace to the 23.6% Fibonacci retracement of the January to June bear move, we're now seeing a bounce and a close above that downtrend, creating the potential for a run higher.

1.1550 is an important level in the near term, marking where the pair stalled on Monday. If we manage to hold above that level, it opens the door to a test of the 100-day moving average. It has a much more chequered history in terms of influencing price action than the 50- and 200-day moving averages, but a push beyond it would put the 38.2% Fibonacci retracement of the January to June bear move, and more importantly, the 200-day moving average, into focus.

A break above the latter would be significant given the way price has interacted with it in the past, creating the potential for a much larger bullish move.

Of course, if the pair fails to build on the breakout and retraces back beneath the trendline, it would add to the sense that bears remain in the ascendency. That would bring the 23.6% Fibonacci retracement of the January to June bear move, along with the confluence of former resistance at 1.1480 and the 50-day moving average, back into play. A break beneath that zone would point to a much larger unwind towards the July lows.

The oscillators favour the breakout sticking. RSI (14) continues to set higher lows and higher highs while moving further away from the neutral 50 level, but is not yet overbought. That message is confirmed by MACD, which has flipped positive and continues to diverge further away from the signal line, building upside momentum. It's not a screaming buy signal by any stretch, but it does favour buying dips and bullish breakouts rather than trying to play it from the short side in the near term.