Since June of last year, the movement of the euro against the dollar has been rather one-way, with the market focusing heavily on the political and economic divergence between the eurozone and the United States.
As much as European growth prospects improved, the Russian-Ukrainian conflict proved to be a reality check, adding to inflationary pressures and soaring energy costs. Perhaps the only real bright spot for the euro is that the ECB has moved from its dovish stance to accelerate rate hikes from the third quarter of this year.
That said, against the backdrop of a likely deterioration in the economy, the window for policy tightening may only be short-lived. But that hasn’t stopped the markets from believing that the ECB can deliver quite aggressively. As it stands, money markets have priced in some 110 basis points of central bank rate hikes for this year. This represents at least four rate hikes of 25 basis points and will put an end to the “experiment” of negative rates in Europe, at least for now.
On that front, I would say markets have “completely” priced in what the ECB can do this year, but the same can be said for how markets view the Fed as well. The ECB shift is arguably more monumental in terms of symbolism and that in itself may cause markets to react more strongly to Fed policy pricing.
But we’ll have to take things slowly and gradually on this one. A lot can still change by July and the risks could be even more skewed on either side of the equation. For now though, the recent hawkish rhetoric from the ECB is at least doing the euro no harm.
For my part, I am also rather intrigued by the technical photo seen above. EUR/USD has been under heavy downward pressure in recent months and the fall from 1.1000 in April to 1.0400 at the start of the month came quickly. The dollar has been on a roll and it might be time for a bit of a retracement, especially with the ECB officially confirming a change in policy direction.
Added to this is key support around 1.0400 with December 2016 lows around 1.0340-66 helping limit the latest downside momentum. This is a major level to hold and helps buyers find some breathing room for now.
I would say that given the fundamentals, a bounce towards 1.0800 is certainly plausible. But given that the Fed is likely to face fewer challenges in policy tightening than the ECB, any prolonged rally towards 1.1000 is likely to be sold. Of course, this all hinges on the inflation narrative in the coming months, so reliance on data is rather key to the outlook.