EUR/USD attempts recovery as U.S. event risk loomsElection matters short-term but latest CPI the highlightU.S. inflation gains could scupper EUR/USD recoveryAny signs of 'peak CPI' could prompt breakout to 1.02
Above: Lady Justice statue, Frankfurt © Adobe Images
The Euro to Dollar rate entered the new week on the front foot but may have scope to build on its recovery in the days ahead, with an approach of three-month highs around the 1.02 possible, if this week's U.S. inflation data encourages the recent correction in U.S. Dollar pairs to extend further.
Europe's single currency outperformed most major counterparts on Monday as it and financial markets overlooked the latest remarks from China's public health officials, some of whom quashed earlier market speculation suggesting that a change in Beijing's approach to the coronavirus is likely in the near future.
Speculation about possible changes in China's approach lifted most currencies on Friday and appeared to weigh heavily on the Dollar, although Monday's reckoning for the Renminbi had little obvious impact on market sentiment and did not prevent the Euro or risky assets from rising.
This leaves much about the performance of the Euro to be determined by the market response to Tuesday's congressional elections and the details of Thursday's inflation report for October in the U.S., which are the highlights of what is a quiet period for European data.
"Evidence that inflation remains uncomfortably high, coupled with hawkish Fedspeak, should support the USD’s rate and yield advantage across the board," says Valentin Marinov, head of FX strategy at Credit Agricole CIB.
Above: Euro to Dollar rate shown at daily intervals with selected daily moving-averages and Fibonacci retracements of February fall indicating possible areas of technical resistance for the Euro. Click image for closer inspection.
"Tomorrow’s US midterm elections are expected to lead to Congressional gridlock. The surprise would be if the Democrats manage to keep the House and Senate, which would raise the risk of more government spending, higher UST yields and, thus, a stronger USD," Marinov also warned on Monday.
Thursday's inflation figures will impact the outlook for Federal Reserve (Fed) interest rates and so could be the difference between whether the Euro ends this week up near to three-month highs around the 1.02 level or back down near to last week's lows just beneath 0.98.
The latter would be most likely if Thursday's data suggests that inflation rose again in year-on-year terms last month because this kind of outcome would force the market to consider again how much further the Fed could feel compelled to lift its interest rate next year.
"The key takeaway from the last couple of weeks is that the Fed is pushing the terminal rate higher while other central banks are signaling a smaller cycle," says Sid Bushan, an economist at Goldman Sachs.
"The market reaction will be especially important to watch after lackluster Dollar performances following two key recent releases—last month’s CPI and last Friday’s payrolls report," Bushan said on Monday.
Above: Euro to Dollar rate shown at weekly intervals with selected moving-averages and Fibonacci retracements of February fall indicating possible areas of technical resistance for the Euro. Click image for closer inspection.
Economists are looking for U.S. inflation to have fallen a touch in October but any surprise increase would have Euro-bearish implications after Fed Chairman Jerome Powell said last week that earlier data already justified an even steeper increase in interest rates for next year than was projected back in September.
"We are not so sure why the market is having trouble coming around to the idea that this is no ordinary cycle. It does not take much to realize that the Fed has never stopped a tightening cycle below y/y core inflation. Why should the worst inflationary shock in decades be any different?" says Mark McCormick, global head of FX strategy at TD Securities.
"We expect a 0.4% m/m reading (consensus at 0.5%). We reckon we will need to see at least two but probably three months of moderating core momentum before markets can take solace in the idea that the current terminal rate estimate (TD: 5.5%) is even remotely close to being correct," he adds.
September's forecasts had implied that U.S. interest rates could reach 4.5% by year-end and 4.75% early in 2023 but last week's press conference led financial markets to begin entertaining the idea that the eventual peak for the Fed Funds rate is now likely to be somewhere above the 5% level.
This lifted the Dollar and weighed heavily on the Euro at the time and if any stronger-than-expected inflation outcome on Thursday can be expected to encourage renewed speculation of that natutre, then it would would pose a risk to the tentative recovery underway in EUR/USD.