Published: July 26th, 2023
The Euro to Dollar rate began this week under pressure and could be at risk of sharper losses if a cautious European Central Bank (ECB) adds fuel to perceptions that Europe’s continental economy is deteriorating when it updates EUR monetary policy on Thursday.
The single currency dropped back toward mid-month lows at the start of this week as its recent rally began to unwind. Analysts said it was responding to the most recent S&P Global PMI survey, which pointed to output from the single market’s manufacturing and services sectors falling at the fastest pace seen in eight months, as July draws to a close.
‘For EUR it's obvious that the PMI print wasn’t helpful,’ said a market commentary from Societe Generale’s FX Strategy Unit. 'USD is up against both Yen and Euro as the new week begins while traders watch to see what the ECB will say on Thursday and the Bank of Japan will say on Friday.’
'If markets continue to blend a large Euro long with underwhelming European data, EUR will need support from future US prints to avoid surrender on some of the trades.’
News from the EU’s two largest markets, France and Germany, suggest Eurozone growth may be sputtering. France posted notable cooling in economic output in July while Germany’s economy also began to slow. The only consolation for central bankers in Frankfurt will be indications that inflation pressures also seem to be on the wane, with prices falling back in key categories this month.
‘As we see growth performance move in different directions across multiple sectors, a mirroring effect is happening in relative-price trends,’ added Societe Generale. ‘The input and output price indices for manufacturing, for example, fell to levels last seen in 2009.’
In June, analysts were looking for a stronger USD across the board. A report from London-based Capital Economics predicted a positive trajectory for the Greenback across June and July, with key events on the horizon including policy meetings by the European Central Bank (ECB) and the Bank of Japan (BoJ).
The research firm said the ECB would be expected to hike interest rates, and many analysts thought at least one more 2023 rate rise would be on the cards for late July. Frankfurt’s June decision followed a US inflation data print that set the stage for future Fed decisions on whether to pause or extend its rate hike cycle.
‘Consensus sees the Fed keeping rate hikes on hold and most analysts expect the Bank of Japan to hold the line as well; however, a few holdouts are looking for the BoJ to make an adjustment to yield curve control on Thursday.’
Noting the complexities around the Fed’s June decision, Capital Economics said recent data had supported arguments for both a pause on interest rate hikes, and a rise.
When the wider market outlook was considered, it underscores the impact of G10 monetary policy and inflation on the Greenback’s performance. "For Dollar bulls, Fed decisions weigh heavily on trading decisions. However, US growth is stubbornly strong, and inflation has been sticky. Traders have to look at the Fed's base case, which is higher for longer. That’s a positive for USD.’
The US Dollar Index (DXY) has retraced recently. After a recent ascent towards 105, it's now falling back slightly around the 100-day moving average to touch 103.38. Capital Economics believes that unless a dovish pause happens, USD will regain strength throughout the week, possibly surpassing the 105 level.
In February, analysts at global investment bank Mitsubishi UFJ Financial Group (MUFG) pegged the Dollar to push back against a resurgent Euro. EUR, they said, would remain on the back foot as USD staged a comeback from late January.
Forex traders, they said, were shrugging off the imminent release of minutes by the US Fed’s open markets committee and downplaying the impact of recent PCE deflator data. MUFG said all signs pointed to a period of Dollar dominance.
‘The upward adjustment to a higher terminal rate and cooling rate cut expectations for later in 2023 have spurred new life into the strong USD trade we saw at the end of 2022,’ says MUFG’s briefing.
Adding wind to USD’s sails is a lifting of investor expectations about the timing of the Federal Reserve's peak interest rate hiking cycle.
In January, consensus had the last rate rise set for March, but an additional two hikes have since been added to the table. The likelihood of a rate cut in the latter part of 2023 has receded, giving the Dollar support after an underwhelming end to 2022 and beginning to 2023.
EURUSD rushed toward 1.10 in January but had fallen back by early February as new US economic data flummoxed analysts, who sent mixed signals into the market.
A surprising mix of strong wage data, labour market dynamics, inflation figures and retail sales suggested the American economy was robust enough to achieve the Fed’s above-target inflation levels. EURUSD started to retrace previous gains as a result.
‘Stronger American growth data blended with firmer inflation at the beginning of 2023 has added optimism to markets. Forex traders are now pricing-in a more hawkish outlook for Fed policy’.
In the Spring of last year, surging oil prices were driving EUR toward multi-year lows as forex traders bet that Frankfurt would hold off om plans to raise interest rates later in the year.
In April 2022 the price of Brent Crude spiked north of USD 130 per barrel, the highest level seen in nearly 13 years. At the same time, wholesale gas prices doubled from the previous month against worries that the US would seek to ban Russian oil from global markets.
Washington and Brussels did manage to restrict purchases of Russian oil and gas amongst G7 countries. European natural gas prices responded by reaching a new all-time high.