EUR/USD outlook: PMI day arrives as Fed hike bets bolster the dollar

• PMI day puts EUR/USD support in focus
• Fed hike bets keep dollar supported
• Euro faces crucial test at 1.1400
• Strong US data widens transatlantic divide

PMI day takes centre stage (in Europe)

PMI day is upon us, perhaps the most brilliantly orchestrated non-event in financial markets. S&P Global has essentially taken a sentiment survey and managed to plonk it right in the middle of what has traditionally been one of the quieter periods of the month for scheduled economic data. The result? It receives far more attention than it probably deserves.

That's not to say the surveys are irrelevant. They do have some relationship with subsequent hard economic data, and markets will happily react when the results deviate significantly from expectations. But let's not pretend they're anything more than what they are: a survey. In the United States, traders tend to pay far more attention to the ISM reports, which are broader in construction and carry a longer pedigree. In China, the influence has whittled away over the years. Europe remains the notable exception, where PMI day can still move markets, particularly the euro.

As such, EUR/USD looms as the pair to watch today with PMI releases due from both sides of the Atlantic. 

The two PMI components that matter

Source: TradingView

The enthusiasm of European economists for the release is perhaps best illustrated by the level of detail contained in the consensus forecasts. Despite being a flash estimate based on only 85-90% of responses, forecasters have happily gone to work producing precise projections for each of the major components.

For the euro area, consensus expects a modest improvement in the composite and services measures, although both are forecast to remain below the 50 level separating expansion from contraction. Manufacturing is expected to hold just above that threshold. Beyond the headlines, the key focus will be on new orders and prices. With the recent energy shock lifting costs across the region, traders will be looking for clues on whether demand is beginning to soften and whether inflationary pressures are proving more persistent than anticipated.

The US surveys are expected to show activity continuing to expand across both manufacturing and services. As with the euro area report, new orders and prices may be the most important details beneath the surface. Strong demand and firm price pressures would fit with the prevailing narrative of a resilient economy and a Federal Reserve that may need to resume raising rates later this year. Anything that challenges that view could, at the margin, soften the dollar.

The Fed repricing gathers pace

The dollar's strength on Monday was notable given it came alongside a sharp unwind in crude oil prices, breaking a relationship that has often held in recent months. Despite the decline in energy prices, buyers emerged early in Asia, helping to lift the greenback broadly.

Source: TradingView

Part of the explanation may have come from a further shift in Fed expectations. Reports emerged that both Bank of America and Deutsche Bank now expect the Federal Reserve to resume raising rates this year, reinforcing a move already evident in market pricing. The prospect of multiple rate hikes, following last week's hawkish pivot from Fed Chair Kevin Warsh, helped underpin demand for the dollar.

Source: LSEG

The shift in expectations is not overly surprising from a fundamental perspective. Citi's Economic Surprise Index, which tracks whether economic data are outperforming or underperforming expectations, has continued to move in favour of the United States, reflecting a run of stronger-than-expected releases. Combined with signs of a renewed inflationary impulse, it helps explain why markets are increasingly discussing additional Fed tightening. Unlike Europe, where policymakers are grappling with weak growth and an energy-driven inflation shock, the case for higher rates in the United States is being underpinned by economic resilience and persistent price pressures.

That divergence is showing up in EUR/USD.

The battle around 1.1400

Source: TradingView

Be it the price action, the message from the oscillators, or the fact the pair now sits in a clear downtrend beneath all its key medium and longer-term moving averages, it continues to favour playing EUR/USD from the short side. That puts the March swing low at 1.1412 and the psychologically important 1.1400 big figure firmly in focus.

The pair begins Wednesday's session just above that zone. While buyers have managed to defend it over the past two sessions, the rebounds have been marginal at best. As a result, it remains the key level to watch heading into today's PMI releases.

Should the post-Fed decline extend, particularly if EUR/USD closes beneath 1.1400, the lower boundary of the support zone, it may embolden bears to look for a far larger unwind. Below the March lows, there is little in the way of meaningful technical support until 1.1200, making it the next major downside level to watch. Shorts could be established on a break beneath 1.1400, using a stop above the level for protection while targeting lower levels.

On the topside, if support between 1.1412 and 1.1400 holds, attention shifts to 1.1500 and then the 23.6% Fibonacci retracement of the January-March decline at 1.1570. Beyond that sits a formidable moving average zone comprising the 50, 100 and 200-day averages.

The message from the oscillators remains unequivocally bearish. RSI (14) has broken its modest uptrend and continues to trend lower, sitting just above 30. MACD is delivering a complementary signal, having registered a bearish crossover while continuing to diverge from the signal line. Downside pressure is building, keeping the focus squarely on the support zone ahead of today's PMI releases.