Published: August 16th, 2023
A new research note from Germany’s Commerzbank says EUR/USD faces a near-term pullback below 1.11 thanks to central bank dynamics. However, there are better times ahead for EUR bulls as a Eurozone recovery will likely be in full swing by year’s end.
‘We expect to see strong US data in the coming weeks relative to the Eurozone, which suggests that traders are pricing in higher expectations for another rate hike by the Fed. 'When that happens, the terminal rate will make the Dollar attractive against the Euro.’
Consecutive economic data prints that have exceeded consensus expectations suggest America’s economy is more resilient than forecasters expected. Commerzbank analysts are now confident that the Federal Reserve can tackle inflation and sidestep a recession at the same time.
The changed dynamic has raised the odds of another rate hike in September, pushing up Dollar exchange rates as a result.
But the bank’s analysts add that Washington and Frankfurt are close to negotiating a terminal interest rate, so moving a few basis points in either direction is unlikely to be a game-changer.
More important is what comes next, namely who lowers interest rates first, and to what extent.
Commerzbank economists see the Eurozone’s current economic doldrums abating towards the end of the fourth quarter.
At the start of the year, ING Bank said EUR/USD had regained a level not seen since June 2022 after extending a strong recovery. A stronger Euro was finding support from Eurozone energy markets and a retreat by the Greenback driven by economic data. ING said it believed further gains were possible.
The pair opened the new year in retreat against a recovering Greenback, but after a retracement it leapt to a multi-month high on Monday 9th January, as forex traders quickly discounted rumors of an end to the US Federal Reserve's interest rate hiking cycle.
In a note to investors, analysts at the Dutch bank’s FX analysis unit said the pair had been ‘impacted by a Dollar sell-off and market bias could send it even higher. We are seeing parallels with the summer of 2007 when a slowdown in America’s housing market gave rise to expectations that the Fed would have to take its foot off the gas.’
Reviewing the price action that dominated the pair that year, ING said American two-year bond yields disintegrated to 2.6 per cent after experiencing trade in the 4.5 to 5 per cent range for the first half of the year. By December 2007, EUR/USD had rallied back by 10 per cent.
The Greenback tracked American yields higher in 2022 as global investors looked for better returns, therefore USD would be expected to retreat if this bond market dynamic went into reverse. ING says this is currently what’s happening.
The ECB said in December 2022 that it was ready for two more interest rate rises of 50 basis points, catching investors off-guard as they were gauging whether Frankfurt would slow down.
The US Fed then signaled that it would ease back soon. Forex traders started looking for the next 25 basis point hike, which was below what the ECB seems to have ‘priced in’.
In June 2022, EUR/USD was trying to climb out of a trough that saw it sink to five-year lows. EUR needed intervention from the European Central Bank (ECB) to beat an already hawkish Dollar market and sustain its recovery momentum ahead of the latest US inflation data print.
The single currency gained substantial support from a hawkish market that re-priced its expectations for ECB interest rate action in advance of the central bank’s late June policy meeting.
The meeting announced the end of Frankfurt’s last and longest running quantitative easing (QE) programme, while providing insights into the future path of European interest rates.
However, forex traders were focused on anything that signaled the ECB’s likely policy direction in July and September, particularly any guidance about the lift Eurozone interest rates could get in July.
In a note to investors, Barclays European Economics Unit said that EUR/USD could rise in the Summer ‘thanks to a more hawkish European Central Bank coming out of Friday’s meeting and a weaker Dollar. In that scenario we believe upside resistance at 1.0789 will be tested.
‘We will be closely monitoring post–meeting communications from the June meeting for indications that the tightening cycle is going to become more aggressive. There is even a small possibility that the ECB decides to raise rates this week.’
Sturdy political tailwinds out of Italy, when markets reacted warmly to the appointment of neoliberal technocrat Mario Draghi as Italian Prime Minister.
After President Sergio Mattarella was re-elected in January, analysts thought the election result would establish policy continuity and enable Draghi to move ahead with EU-mandated policy changes required to obtain EUR 200 billion in EU funding.
Analysts at the time said Mattarella’s return to power was positive news for markets and a euro rally off the back of the news got underway. The EUR/USD rate also rose from a multi-month low seen the previous week.
It was clear however that chart trends were still favouring USD in the short term, with the future outlook depending then, as now, on announcements from the next ECB policy meeting.
Frankfurt avoided making major changes to interest rate policy at its February meeting but did flag its concerns about early indicators of rising inflation, both in the Eurozone and globally.
Consensus at the time looked for ECB bankers to raise rates by the end of this year, with the Euro outlook driven by whether or not Frankfurt policymakers met that expectation.
A market analysis of Euribor prices suggested that investors were moving their expectations for the timing of an ECB rate rise forward, with December 2022 seen as the most likely date. This was, of course, all before the conflict in Ukraine and its knock-on effects to energy and food prices.