EURO FORECAST:
- U.S. Treasury yields corrected lower in May, but have resumed their ascent. This may complicate the euro’s recovery
- May U.S. jobs numbers could help cement expectations of another 50 bps Fed hike in September if data show the labor market continues to tighten
- This article looks at EUR/USD key technical levels to keep an eye on in the near term
Most Read: Euro Finds Support but Downside Risks Remain
U.S. Treasury yields began a moderate correction in early May on speculation that weakening U.S. economic activity would lead the FOMC to slow its aggressive tightening cycle over the forecast horizon. The pullback in rates accelerated later in the month after Atlanta’s Fed President, Raphael Bostic, a non-voting member of the central bank, signaled policymakers could potentially pause interest-rate increases in September. Against this backdrop, the DXY index posted a sharp decline from its 2022 high recently, boosting the euro and other currencies, but the weakness may begin to reverse soon.
Looking ahead, the outlook for monetary policy will likely be one of the most important catalyst for foreign exchange markets in the coming months. While expectations may change, traders are increasingly convinced that the Federal Reserve will not veer off course, but press ahead with the strategy to front-load hikes in the near term.
After the 50 basis points adjustment in May, Wall Street assumed that the Fed would continue to raise borrowing costs at that pace in June and July, but then return to the standard 25 bp move at subsequent meetings. Now, however, bets are increasing that the bank will deliver another half a percentage point hike in September, with traders assigning a 64% probability to that scenario, up from 35% a week ago.
Although U.S. activity data is cooling, the economy is still holding up well, as evidenced by the May ISM manufacturing survey, which showed robust expansion in the industrial sector. The report suggests that the tightening of financial conditions has not yet cooled demand sufficiently to curb inflationary pressures, a sign that a more aggressive response in withdrawing accommodation may be needed.
May U.S. Non-Farm Payroll data may help cement expectations for another jumbo rate increase at the tail end of the third quarter if hiring remains robust. The economy is likely at full employment, so strong job creation could accelerate wage gains, reinforcing price pressures at the worst possible time, when CPI sits a four-decade high.
In the current environment, the euro will have difficulties continuing its recovery against the U.S. dollar. While the ECB’s pivot towards a more hawkish stance and its pledge to exit negative rates by September has buoyed the common currency in recent days, yields may not go substantially higher in Europe without raising fragmentation risks. In the U.S., on the other hand, rates could reprice higher as Fed officials have shown willingness to be more forceful if needed to achieve their mandate. That said, with energy costs soaring again, it will likely take stronger action to restore price stability.
EUR/USD TECHNICAL ANALYSIS
After the recent upswing, EUR/USD is trading near cluster resistance in the 1.0740/1.0765 area, where the 50-day simple moving averages converges with a short-term descending trendline and the 38.2% Fibonacci retracement of the 2022 decline. If bulls manage to clear this hurdle decisively, we could see a move towards 1.0925, the 50% Fib retracement.
On the flip side, if sellers return and trigger a bearish reversal, initial support stretches from 1.0650 to 1.0630. On further weakness, the focus shifts to the psychological 1.0500 zone, followed by the May low around 1.0350.
EUR/USD TECHNICAL CHART
EUR/USD Chart Prepared Using TradingView
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—Written by Diego Colman, Market Strategist for DailyFX
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