EUR/USD the Key for USD Trends into FOMC

EUR/USD, Euro Talking Points:

• While the US Dollar has had a bullish outing for the past six months much of that move has been fueled by the Japanese Yen falling to fresh 40-year lows.
• The Euro is a much larger component of the DXY basket and since the June sell-off, sellers have largely been stalled. There remains technical structure in place for bears to make a run and this week’s FOMC meeting will probably be a big part of that.

It’s difficult for the US Dollar to go anywhere without at least some participation from the Euro. After all, the single currency is a whopping 57.6% of the DXY basket and the second largest component, the Japanese Yen, is a mere 13.6% composition. This is largely owed to when the basket was made and the fact that it was conglomeration of European currencies with the advent of the Euro that created such an outsized allocation.

There will, however, be times where capital flows can throw a wrench in the matter, and we had an example of this back in the summer of 2024. At the time growth in Europe wasn’t exactly in a great place, and as the world prepared for rate cuts from the FOMC, USD/JPY broke down in a very big way. That USD-weakness in an unwind of a massive carry trade drove Dollar weakness elsewhere, too, even in the Euro which saw EUR/USD pop up for a test and hold at the 1.1200 handle.

This is important, perhaps, for what might be around the next corner, but there’s a few pieces that would need to fall into place first for that to be a scenario to entertain.

For this week it’s all about the FOMC meeting. And perhaps surprising is just how hawkish Kevin Warsh has sounded since taking over at the Fed. This runs counter to the pledges Trump made on the lead-in to the nomination, even going as far as saying that a willingness to cut rates was a litmus test for whomever he would ultimately select. I wrote about this in an article earlier today, and since taking over at the Fed Warsh has made repeated comments about needing to tackle inflation. If one didn’t know any better they might think we have the reincarnation of Paul Volcker at the helm, although I think there’s something else going on there and we just might get the next data point in that series this week.

With inflation data high as Warsh took over, he needed to sound as though he was at least open to rate hikes or else markets would just simply plot for more currency debasement and weak monetary policy. Like we saw with the Fed’s rate cuts in 2024 just ahead of the US election, market participants aren’t stupid – and if inflation is high and the Fed is cutting rates, well inflation expectations go up. That drives up longer-term bond yields, and, in-turn, mortgage rates.

The Fed cutting rates doesn’t mean the Treasury yield curve is going to drop and in cases like we saw there, it can have a counter-active effect on long-term rates.

EUR/USD Weekly Chart: Rate Anticipation Driving the Flows

Chart prepared by James Stanley; data derived from Tradingview

Warsh knows this, and he probably also knows that while stocks were near highs even as inflation remained elevated it made little sense for him to pledge to rate cuts later in the year, even if that’s what everyone knows President Trump wants to see and hear, particularly as we go into mid-term elections.

The question for now is whether Warsh will retain that hawkish rhetoric on Wednesday as equity prices have started to show vulnerability? The consequences of such could be wide ranging, as a hawkish Warsh would not only expose the possibility of more weakness in equities, but also USD-strength which would then put pressure on the Bank of Japan at their rate decision a day later. And USD/JPY getting closer to a 165 handle brings on the threat of intervention which could serve similar impact as what we saw back in July of 2024.

Right now – there’s the building expectation that the Fed may hike rates to address still-elevated inflation. This is what we saw take over in June after the FOMC meeting on the 17^th, which led to a downside break in EUR/USD.

EUR/USD Daily Chart

Chart prepared by James Stanley; data derived from Tradingview

EUR/USD: An Open Door for Bears

At this point pretty much the only bullish thing that can be claimed on EUR/USD is the fact that the sell-off has seemingly stalled below the 1.1400 handle. But, so far, sellers have shown reaction in the way that one would probably want to see, given the resistance on the underside of the channel making up the bear flag formation, which was broken after ECB last week with a bearish engulf pattern.

The key for whether this can continue likely boils back to Kevin Warsh and the Fed, and if the Fed does continue with a hawkish bias then the argument for a downside break and test of that prior low of 1.1325 makes sense.

Below that, next supports are 1.1275 which is a key Fibonacci level and then the 1.1200 handle that capped the highs back in 2024 as markets were priming for the Fed to start cutting rates.

For invalidation – there were a few different tests around the 1.1469 level but really I think it’s a closed body break on the daily chart above the 1.1500 handle that would be needed to signify failure from sellers.

EUR/USD Four-Hour Price Chart

Chart prepared by James Stanley; data derived from Tradingview

--- written by James Stanley, Senior Market Analyst, Global Macro