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The Euro to Dollar exchange rate looks vulnerable to further declines over the coming days, with attention falling on the European Central Bank interest rate decision and the release of a key inflation gauge in the U.S.

2024 has seen a strong U.S. Dollar comeback, and there is little on our radar that suggests that this cannot extend.

Euro-Dollar has nevertheless found support from receding ECB rate cut expectations and the 200-day moving average technical support level, currently at 1.0846.

Moves below this support are unlikely in the opening part of the week:

Above: EUR/USD at daily intervals. Track GBP with your custom rate alerts. Set Up Here.

Shaun Osborne, an analyst at Scotiabank, says the Euro-Dollar looked vulnerable to more downside movement last week, but the market (twice) tested and held the mid-1.08 area, where the 200 DMA is currently located.

"The lack of follow-through selling pressure has averted more EUR losses for now, at least," says Osborne.

"The market undertone remains soft, however, with short-term trend oscillators and longer run price signal leaning EUR-negative," he cautions.

Fawad Razaqzada, Market Analyst at City Index, says EUR/USD displays signs "that the bulls have been trapped, given its inability to hold above last week’s hammer candle and support at 1.0877".

"So, there is an increased risk now that this bearish reversal could trigger a move to below Wednesday’s low of 1.0844, where some sell stops are undoubtedly resting," he explains.

Image courtesy of City Index.

Look for volatility on Thursday when the European Central Bank (ECB) is expected to keep rates unchanged and continue to push against the aggressive market rate cut expectations.

While this has supported the Euro, particularly against other non-USD pairs, it has become a consensus expectation heading into the January decision. This is because a host of ECB speakers attending the Davos forum made it clear a rate cut in the first half of 2024 is not going to happen.

Thus, the bar for further 'hawkish' developments that can boost Euro exchange rates is set high.

"We believe there may be scope for a dovish surprise on 25 January," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole. "Especially if the ECB signals that it is focusing on any evidence of second-round disinflation effects, e.g., peaking wage growth and services inflation, that could keep core inflation trending lower."

Above: ECB President Christine Lagarde said last week that interest rate cuts were a question for the summer rather than in spring. File image of ECB President Lagarde. Credits: World Economic Forum, Swiss-image.ch, Photo: Valeriano DiDomenico.

The ECB could also play down the inflationary impacts of the potentialy inflationary developments related to attacks on shipping in the Red Sea, noting them as transitory.

"We believe that the single currency will continue to take its cue from the price action in the Eurozone rate and yields. The single currency should remain vulnerable to the extent that

any dovish ECB surprises and/or downside economic surprises erode the EUR's rate and yield appeal," says Marinov.

Ahead of Thursday's decision, keep an eye on Eurozone PMIs for signs that the Eurozone economy struggled in January.

The Euro has proven sensitive to this release in the past, and the consensus is looking for the composite to read at 18.1, manufacturing at 44.8 and services at 49.

Because sentiment towards the Eurozone is so poor, the biggest reaction function lies to the upside on any gloom-defying prints.

Above: The USD has dominated in 2024.

The only real question to ask is whether there is anything on the economic docket that can halt the fading expectations for a March rate cut at the Federal Reserve in the coming days.

In short, no, and this is why the Dollar can be favoured as we head through the second half of January.

"The high-yielding, safe-haven USD has regained ground across the board of late as central banks’ concerted pushback against overly dovish market expectations has finally started to bear fruit," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

"Higher U.S. and global yields have weighed on risk assets, resulting in tighter global financial conditions, burnishing the currency’s safe-haven appeal," he adds.

Crucially, he says this trade that supports the Dollar has further to run:

"With the U.S. rates markets still attaching a c.50% chance to a Fed cut in March and pricing in c.130bp worth of rate cuts in 2024, we believe that the reassessment of the dovish market expectations is not over yet."

This week's domestic focus for the Dollar falls on Thursday with the GDP release and the PCE inflation gauge.

Above: "GDP growth likely slowed in 4Q to a moderate pace" - UniCredit.

The U.S. core PCE reading for December forms the final major release ahead of the 31 January Federal Reserve policy meeting and thus could attract considerable attention.

In a weekly currency briefing, Crédit Agricole's Marinov says investors should focus on the risk of any downside surprises from the data given that the latest U.S. PPI data came in on the softer side and given that shelter costs – one of the key drivers of core CPI inflations upside surprise in December – enter Core PCE with a smaller weight.

But, with many Fed-related negatives still in the price of the USD, it would take notable downside inflation surprises to weigh on the currency ahead of the January Fed policy meeting, according to Marinov.

Indeed, Crédit Agricole's economists note recent data releases have suggested that the U.S. labour market remains tight and continues to fuel wage growth and thus domestic demand while

the U.S. disinflation process seemingly stalled in December.

"We expect that these developments could force the Fed to remain more hawkish than expected by the markets at present, in a boost to the USD’s relative rate appeal across the board," says Marinov.