EUR/USD outlook: Could dollar resume higher?

The EUR/USD edged higher Monday morning after GDP and core inflation from the Eurozone came in a touch higher than expected and ECB’s President Lagarde said the central bank could hike again, even if it pauses at its next meeting. But after a dovish ECB and strong performance from the dollar last week, the EUR/USD outlook was somewhat bearish, meaning there was the potential for it to correct further lower.

The EUR/USD’s gains in the first half of Monday’s session comes after the single currency fell sharply on Thursday after the ECB signalled that a pause in interest rate hikes could come as soon as September, which took the markets by a bit of surprise. But Lagarde has now warned that “there could be a further hike of the policy rate or perhaps a pause,” in September, adding that a pause, “whenever it occurs, in September or later, would not necessarily be definitive.” still, the market is convinced that the ECB’s policy tightening is nearing an end, which is party why the German DAX index is finding itself at a fresh record high of around 16,500 today.

 

Eurozone data mixed

 

With economic activity being subdued at best, inflation is starting to fall in the Eurozone, although services inflation remains a concern.

On Friday, German CPI for July came in as expected and cooled to 6.2% YoY, down from 6.4%, which further fuelled bets that the ECB won’t hike in September. Following the in-line German CPI data, no one was surprised to learn that the Eurozone CPI was also bang in line today, at 5.3% compared to 5.5% in June. But core Eurozone CPI was a touch higher than forecast at 5.5%, unchanged from June which got revised higher from the initial estimate of 5.4%. Services inflation remains high because wage growth continues to push up input costs for service providers.

On top of the higher-than-expected core inflation print, Eurozone GDP for the second quarter came in surprisingly stronger at +0.3% than +0.2% expected. However, this was offset by Q1 GDP being revised lower to -0.1% from +0.1% initially estimated.

But the more forward-looking indicators paint a bearish picture for the Eurozone economy, and thus the EUR/USD outlook. Last week, for example, the latest PMI data from the Eurozone showed weakness again. The manufacturing sector PMI activity has been in contraction for 13 straight months now and deteriorating. Worryingly, the services sector activity also came in weaker this time, even if the PMI still remained in expansion territory.

 

EUR/USD outlook: Will the dollar resume higher?

 

All told, the EUR/USD’s gains were mild in the first half of Monday’s session. Investors are wondering whether the US dollar has bottomed out, at least temporarily. There’s certainly a risk the greenback could gain more ground ahead of a busy week, after closing higher for the second consecutive time last week against a basket of foreign currencies.

The greenback has found renewed strength in recent days thanks to data highlighting the resilience of the world’s largest economy, where signs of disinflation have been offset by strength in consumption, suggesting that a severe recession can be avoided, even with interest rates at 5.5% -- the joint highest with New Zealand among the developed economies.

In the eyes of the Fed, monetary policy is quite restrictive now, and further rate increases might be avoided. But with the world’s largest economy holding its own relatively well, this means monetary policy may remain restrictive for longer than perhaps some other important economic regions around the world.  

There’s about 2 months until the Fed meets again, which means a lot can change in the interim in terms of data. Inflation is obviously in focus. But the Fed will also keep an eye on other macro indicators in determining whether to hike further.

 

On Tuesday, the focus will be on the ISM manufacturing data, given the weakness we have seen in the sector across the developed economies. We will have the ADP private sector payrolls report on Wednesday, followed by the ISM services PMI on Thursday and then – the big one – the official nonfarm payrolls report on Friday.

 

The dollar’s bullish momentum faded somewhat on Friday, though, after the Fed’s favorite inflation measure – core PCE – came in a touch softer, although this was offset by a stronger-than-expected personal spending print, which was up 0.5% month-on-month. The PCE Core Deflator came in at 4.1% y/y/ vs. 4.2% expected.  Earlier last week, we saw US GDP expanding +2.4% in the second quarter, more than +1.8% expected. We also had better-than-expected Jobless claims data.

 

EUR/USD outlook: technical analysis

 

The first half of Monday was won by the bulls as the EUR/USD held above the 1.10 handle and in the positive territory after Friday’s small recovery. But after Thursday’s big sell-off, the onus remains on the bulls to show dominance, as they have failed to defend some key levels earlier last week. One such level was being tested around 1.1030 to 1.1050, which was previously support. So, it is possible the EUR/USD might resume lower from here and drop to test liquidity below last week’s low at 1.0943.

Even if the EUR/USD were to strengthen a little bit more, this does not necessarily mean it has bottomed – unless we go back above Thursday’s high now. If that were to happen, this would suggest Thursday’s selling was, actually, a big trap for the bears.

Source: TraingView.com

 

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R