EUR/USD Gains Momentum as US Dollar Weakens Ahead of Fed Decision

Recent data shows cooling inflation in the U.S., which could prompt the Federal Reserve to consider lowering interest rates, potentially weakening the USD and strengthening the EUR/USD pair. The US dollar has broken the triangle pattern and appears to be heading lower as the price remains under pressure. On the other hand, the EUR/USD has broken the bullish pattern and is looking upward. This article discusses the fundamental and technical analysis of the EUR/USD to understand the pair’s next direction and identify investment opportunities.

Recap

In the previous article, it was discussed that the recent dip in the Producer Price Index (PPI) to 2.27% suggests cooling inflationary pressures in the US economy, which aligns with a slight decrease in the Consumer Price Index (CPI) to 3.2% for July. This easing of inflation could lead to a potential rate cut by the Fed, which might weaken the USD and strengthen the EUR/USD pair.

However, strong retail sales and declining unemployment claims have created uncertainty about the extent of Fed easing, leading to mixed market reactions and increased bond yields. As the Fed’s September meeting approaches, the EUR/USD exchange rate remains highly sensitive to upcoming economic data and shifting market expectations.

It was also discussed that in 2024, inflation remains uncertain, with various indicators pointing to potential economic challenges ahead. Despite a temporary rebound in U.S. GDP growth in Q2, the economy shows signs of fragility due to tight monetary policy, rising unemployment, and a weakening labor market. An inverted U.S. Treasury yield curve suggests a possible recession, and weakening consumer confidence, coupled with increasing auto loan delinquencies and record-high credit card debt, may reduce consumer demand, easing inflationary pressures.

However, if the economy continues to slow, the Federal Reserve may consider rate cuts to stimulate growth, potentially reigniting inflation. This delicate balancing act could lead to increased volatility in the EUR/USD exchange rate, especially if U.S. economic growth slows and the Fed moves towards a more accommodative monetary policy. The inverted yield curve chart from the previous article is shown below.

From technical perspective, EUR/USD pair was at a technical inflection point, with the daily chart showing a breakout from a triangle formation. Bullish price structures suggested that the pair may break higher. It was discussed that the weekly chart’s inverted head and shoulders pattern indicates a possible breakout and require a close above 1.105 to confirm.

Next Move in EUR/USD After Breaking Key Levels

As expected from the previous article, the EUR/USD has already broken out of the wedge by closing above the triangle line, indicating a major breakout and the continuation of the upward rally. However, the RSI is currently testing the overbought region, suggesting that prices may correct before the next surge higher. Additionally, the weekly candle closing at higher levels without a shadow indicates price strength and a continuation of bullish momentum.

This is also evident from the previous chart, which shows a strong breakout in EUR/USD on the monthly chart from this triangle. This triangle resembles a bullish pennant, and a breakout from this level suggests much higher levels, with an initial target of $1.1278. The consolidation within this triangle indicates price compression on the monthly chart below. On a broader scale, the formation of a falling wedge pattern in the long term suggests that a break from the long-term resistance of the blue line will trigger a strong surge in the pair.

This bullish run in the EUR/USD is supported by the bearish momentum in the US dollar index, as explained in the previous article. The US dollar index has broken out of the triangle pattern and closed at a lower level, indicating bearish pressure may develop in the next few weeks, as shown in the chart below.

The Role of Unemployment Changes in Predicting a Recession in United States

The Sahm Rule Recession Indicator is an economic tool to identify the onset of a recession based on changes in the unemployment rate. It signals a potential recession when the three-month average of the national unemployment rate rises by at least 0.5 percentage points above its lowest point during the previous 12 months.

The Sahm Rule provides a timely signal of economic downturns, before official declarations of a recession, by focusing on rapid increases in unemployment as a key indicator of economic stress. This method measures recessionary conditions by detecting sudden, sustained increases in unemployment, which occur when economic activity contracts significantly, leading to widespread job losses.

The chart below shows that the Sahm Recession Indicator is beginning to rise from its low point. This indicator has not produced any false signals over the past seven decades, suggesting that a recession might be approaching.

Moreover, the KC Fed Labor Market Conditions Index is also starting to decline, which indicates the onset of a recession. As labor market conditions deteriorate, the Federal Reserve may consider lowering interest rates to stimulate economic activity, which can weaken the value of the U.S. dollar by making dollar-denominated assets less attractive to investors seeking higher returns. This is another indicator suggesting lower interest rates in September 2024.

As discussed above, lower interest rates are expected, which is negative for the USD because they reduce the return on investments in U.S. dollar-denominated assets. Additionally, lower rates can signal weaker economic conditions, further diminishing demand for the dollar as a safe-haven currency. This is also supported by the long-term chart for the US dollar index, which shows that after breaking the long-term trend line in 2015, the index initiated a strong rally within the blue channel and hit the major target of this rebound.

After reaching this target, the US dollar index has started to correct lower. The index’s consolidation and weakness in 2023 have resulted in bearish formation patterns, and now the index is on the verge of a strong drop. If this drop develops, the EUR/USD will benefit from this weakness and initiate a strong surge.

Short Term Trend in EUR/USD

Based on the above discussion, the EUR/USD has broken through the inflection area and initiated a strong surge higher. However, the short-term charts indicate extremely overbought levels, though the momentum remains strong. The 2-hour chart below shows a continuation of the bullish rally, suggesting that any price correction could be a buying opportunity. The weekly and daily charts are strong, and August is likely to close higher, breaking the triangle, which indicates a strong rally in the coming months.

Bottom Line

In conclusion, the EUR/USD has broken the inflection area and looks upside. While cooling inflation and potential Fed rate cuts suggest a weakening USD, strong economic data and uncertainty about the extent of Fed easing create mixed signals for the EUR/USD pair. Technically, the pair has broken through key resistance levels, indicating bullish momentum, but short-term overbought conditions could lead to corrections, which might present buying opportunities.

With the U.S. economy showing signs of a potential recession, as indicated by rising unemployment and declining labor market conditions, further developments in these areas could significantly impact the EUR/USD exchange rate. As we approach the Fed’s September meeting, the pair remains sensitive to economic data and market expectations, with the possibility of a strong rally if the dollar weakens further.