EUR/USD: Nearing a Technical Breakout Following Disappointing US Economic Data

This article presents a fundamental and technical evaluation of the EUR/USD to determine its next direction. The pair is trading within a sideways market range and is approaching a pivotal level with an emerging technical strength. Weaker economic data from the USA further strengthens the EUR/USD outlook and suggests a potential market breakout.

EUR/USD Strengthens Due to Weak US Employment and Economic Reports

The recent surge in the EUR/USD exchange rate is attributed to the latest US Nonfarm Payrolls (NFP) report for July, which revealed significant weaknesses in US labour market. The report indicated that US employers hired only 114,000 new workers in July, falling short of the expected 175,000 and the previous month’s revised figure of 179,000. This considerable shortfall has heightened concerns over the US economy’s strength, negatively impacting the US Dollar’s (USD) value. These disappointing employment data have fostered expectations that the Federal Reserve (Fed) may soon begin reducing interest rates, increasing the EUR/USD.

Moreover, the unemployment rate in the US increased from 4.1% to 4.3%, as shown in the chart below. The average hourly earnings growth also dropped to 3.6% annually, below the expected 3.7% and the previous reading of 3.8%. This slowdown in wage growth suggests reduced consumer spending power, potentially easing inflationary pressures. Consequently, this weakening in labour market indicators suggests a cooling economy, prompting speculation of potential rate cuts by the Fed, thus applying additional downward pressure on the USD and supporting the EUR/USD.

The USD has been affected by a series of weak economic data. The chart below shows the July US ISM Manufacturing Purchasing Managers Index (PMI). This data revealed a sharper-than-expected contraction in factory activities, dropping to 46.8 compared to the expected 48.8 and June’s reading of 48.5. This unexpected contraction highlights ongoing challenges in the manufacturing sector, further dimming the US economy’s prospects. These indicators paint a picture of a struggling US economy, thereby weakening the USD and driving the EUR/USD higher.

As the USD weakens, the demand for EUR/USD typically increases due to the inverse relationship between the two currencies. This dynamic is evident given the recent string of unfavourable US economic data, which has dampened the USD’s outlook. Investors anticipate that continued weak labour market conditions and other economic challenges will lead the Fed to adopt a more dovish stance, potentially reducing interest rates.

On the other hand, the Eurozone is also facing economic challenges. The Eurozone’s HICP for July was higher than expected at 2.6%, compared to the forecasted 2.4%. Despite this, the Euro has struggled to recover. The core HICP, excluding volatile items, grew steadily at 2.9%, marginally above the expected 2.8%. Moreover, the Eurozone’s Gross Domestic Product (GDP) growth for the second quarter was stronger than expected, expanding by 0.3% against the forecasted 0.2%. While these indicators suggest steady economic activity, the persistent inflation and moderate growth complicate the European Central Bank’s (ECB) rate policy, as the market currently expects further rate cuts.

The combination of weak US labour market data and inflationary Eurozone economic indicators has driven the recent surge in the EUR/USD exchange rate. The substantial shortfall in US job growth, rising unemployment, and easing wage growth have intensified expectations of Fed rate cuts, weakening the USD. Meanwhile, the Eurozone’s steady GDP growth and higher-than-expected inflation challenge the ECB’s monetary policy as financial markets anticipate further rate cuts.

Effects of Weak Economic Data on the USD Index

The weak economic data from the US has dragged down the USD index to a significant area where a key decision is likely. A breakout from this area could lead to a substantial decline in the USD index and a strong rally in EUR/USD. This significant area is defined by forming a triangle from the last quarter of 2023 to July 2024. Following the peak at 114.75, the emergence of this triangle suggests bearish implications, as the triangle is also referred to as a bear flag. The double tops highlighted by blue arcs at 107.05 and 106.38 also indicate bearish patterns. A weekly close below 102 may trigger a strong drop in the USD index.

Long-Term Technical Strength for EURUSD

The weak dollar drives bullish price action in EUR/USD, as seen in the chart below. The chart also shows a falling wedge pattern development, from the 2008 peak of $1.6038 to the 2022 bottom at $0.9538. The strong rebound from the 2022 bottom has led to a bullish reversal near the long-term resistance area of around $1.14.

The 2023 peak at $1.1276 resulted in price consolidation, forming a triangle referred to as a bullish pennant. This bullish pennant in EUR/USD mirrors the bearish pennant in the USD index. Since the USD index is inversely proportional to EUR/USD, forming these inverted patterns suggests that EUR/USD may break higher towards the $1.14 area. This target aligns with the resistance line from the 2008 financial crisis peak.

Traders’ Perspectives and Short-Term Market Trends

To better understand EUR/USD’s next direction, the weekly chart below zooms in on the triangle formation seen in the monthly chart for more clarity. The rebound from the lows of this triangle was found to be bullish, featuring an inverted head and shoulders pattern with the head at $1.0601. Last week’s strong rally following the NFP release resulted in a solid weekly hammer, suggesting that prices are likely breaking out of the triangle. Additionally, the RSI trades above the midline, further supporting the bullish outlook.

On the other hand, the hourly charts show that the price has already hit the target of $1.0947 and remains overbought. Due to these short-term overbought conditions, the price may soon be corrected to a lower price to attract new buyers. Since the price shows bullish action, traders may consider buying on dips with short-term new targets of $1.11 and $1.12.

Risk Analysis

The disappointment in the Nonfarm Payrolls report, increased unemployment, and slowing wage growth have prompted speculation about potential Federal Reserve rate cuts. This uncertainty can lead to heightened volatility in the USD, which may fluctuate significantly based on evolving economic data or shifts in Fed policy. Such market conditions can create unpredictable trading environments, where the USD’s value might be subject to sudden changes in response to new economic indicators or geopolitical developments.

Geopolitical risks further complicate the currency markets. Rising tensions in the Middle East add a layer of uncertainty, as geopolitical crises can lead to market disruptions and shifts in investor sentiment. Increased instability in this region may drive safe-haven flows, impacting the EUR/USD exchange rate and rising market volatility.

These geopolitical factors can influence global economic conditions and central bank policies, potentially leading to abrupt currency value changes and complicating the complex dynamics between financial data and currency movements. The price shows bullish signals from a technical perspective, but the price structure remains within a triangular formation. Therefore, if market volatility increases, the EUR/USD may continue to trade within a sideways range before any sustainable rally occurs.

Bottom Line

The recent surge in the EUR/USD exchange rate highlights the significant impact of weak US economic data on currency movements. The disappointing Nonfarm Payrolls report, rising unemployment, and sluggish wage growth have intensified concerns about the US economy and fueled expectations of potential interest rate cuts by the Federal Reserve.

This has weakened the USD and bolstered the EUR/USD. However, despite some positive economic indicators from the Eurozone, including steady GDP growth and higher inflation, the Eurozone also faces challenges that complicate the European Central Bank’s monetary policy. The interplay of these factors has driven the EUR/USD higher, reflecting the complex dynamics between economic data and currency strength.

Despite the strong rally, the pair remains in a consolidation phase defined by the triangles’ trend lines. However, the emerging patterns are pointing technical strength. EUR/USD must break out of this triangle to shift the long-term trend. However, the short-term direction remains upward, and any price correction presents a buying opportunity for short-term traders aiming to target the $1.11 and $1.12 regions.