The decline in EUR/USD this morning appears to be largely driven by USD strength, though the euro also seems less stable due to the potential for a dovish shift by the European Central Bank (ECB) compared to the U.S. Federal Reserve. Francesco Pesole, FX strategist at ING, highlights these dynamics.
A retest of the 1.110 support level is possible, as the two-year OIS USD
spread has tightened again below 100 basis points following Fed Chair Powell’s recent speech, currently sitting at 96 basis points. While this spread could suggest EUR/USD trading above 1.12, a softer risk environment is prompting some profit-taking, with speculation that the rate differential might widen again.
Markets are currently pricing in a 50 basis point move by the Fed by year-end (totaling 100 basis points), while the ECB is expected to deliver only 64 basis points over its last three meetings in 2024. This decoupling of Fed-ECB rate expectations may cause unease among investors, with risks leaning toward the ECB pricing in more easing to align with the Fed. Germany’s return to recession in the second quarter could also contribute to this potential realignment.
EUR/USD may face challenges in returning to the 1.120 level in the coming days, especially as the absence of key U.S. data might favor the dollar. A retest of the 1.110 support level is possible. However, Pesole does not see the conditions for a significant unwinding of the recent EUR/USD rally. The upcoming eurozone CPI figures, set to be released tomorrow, will be a crucial test for the ECB-Fed decoupling narrative.
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