EUR/USD Poised at Key Inflection as Fed Decision Looms

As the global economic landscape faces a mix of inflationary pressures, potential recession risks, and monetary policy adjustments, the EUR/USD exchange rate has become increasingly volatile, reflecting the uncertainty surrounding future market movements. Recent indicators suggest that inflation in the U.S. is easing, leading to speculation about potential Federal Reserve rate cuts, which could weaken the USD and strengthen the euro.

Moreover, technical charts show that the EUR/USD pair is at a critical inflection point, with a possible breakout on the horizon. As the market awaits further economic data and the Fed’s next moves, the EUR/USD remains poised for significant shifts, influenced by short-term fluctuations and long-term trends. This article presents a fundamental and technical analysis of the EUR/USD market to determine the next direction of the instrument.

Lower Inflation Metrics Hint at Possible Fed Rate Cuts

The recent dip in the Producer Price Index (PPI) to 2.27% for the 12 months ending in July signals a potential cooling in inflationary pressures within the US economy. This is further supported by a significant drop in monthly growth, as shown in the chart below. A contracting PPI suggests a slowing economy, potentially leading to softer demand for goods and services.

This scenario indicated that the Consumer Price Index (CPI) readings would be lower, which is precisely what happened. The CPI data for July rose by 3.2%, slightly down from the previous 3.3%. Meanwhile, the headline CPI decelerated to 2.9%. These figures suggest that inflationary pressures are easing, making a possible rate cut in September. For the EUR/USD pair, a Fed rate cut typically leads to a depreciation of the USD, as lower interest rates make the currency less attractive to investors. Consequently, this could strengthen the euro against the dollar, increasing the EUR/USD exchange rate.

Moreover, the retail sales data shows stronger than expected numbers. As shown in the chart below, retail sales increased to $615 billion in July. On the other hand, the unemployment claims declined. However, the market reaction to this data has been mixed. While the data is positive, the probability of a smaller rate cut of 25 basis points increased. The bond market responded with higher yields, reflecting uncertainty about the Fed’s next move. For the EUR/USD, this uncertainty can create volatility. If the market begins to doubt the likelihood of aggressive Fed easing, the USD could find some support, potentially limiting the upside for the EUR/USD.

Market participants will closely monitor the upcoming US data, notably the University of Michigan’s Consumer Sentiment Survey Index. An improvement in consumer sentiment could further boost the USD by signalling increased confidence in the US economy. This would likely exert additional downward pressure on the EUR/USD, particularly if it dampens expectations for aggressive Fed easing. However, if the survey disappoints, it could renew speculation about the need for more substantial rate cuts, potentially leading to a weaker dollar and a higher EUR/USD.

Overall, the EUR/USD exchange rate is currently at a crossroads, influenced by a mix of economic data and expectations surrounding Fed policy. While weaker inflation data and the possibility of Fed rate cuts generally favour a stronger euro against the dollar, stronger US economic indicators and mixed market reactions introduce uncertainty. As the Fed’s September meeting approaches, the EUR/USD will likely remain sensitive to incoming data, with the potential for upward and downward movement depending on how market expectations evolve.

Recession Fears in 2024

As discussed above, inflation in 2024 remains uncertain, but several indicators suggest it could be a concern. Despite a temporary rebound in U.S. GDP growth in Q2 2024, the overall economic environment remains fragile, with tight monetary policy and rising unemployment signaling potential headwinds. The Federal Reserve’s interest rate hikes, aimed at controlling inflation, may have a delayed impact, potentially leading to slower economic growth in the latter half of the year.

As the labour market shows signs of weakening, with job creation slowing and the unemployment rate rising, pressure on consumer spending could increase, suppressing inflationary pressures and exacerbating economic slowdown risks.

The chart below shows that the U.S. Treasury yield curve is inverted, a traditional recession indicator. The inverted yield curve is now beginning to turn from its lowest point, which indicates that the economy could be at a tipping point. Recession typically occurs when the Treasury yield curve rises from an inverted position below zero to above zero. Consumer confidence appears to be wavering, as evidenced by increasing auto loan delinquencies and record-high credit card debt.

These factors could contribute to a reduction in consumer demand, which would typically ease inflationary pressures. The easing of inflationary pressures is already discussed in the section above. However, if economic growth continues to falter, the Fed might be forced to pivot towards rate cuts to stimulate the economy. This could reignite inflationary pressures, especially if consumer and business spending begin to pick up in response to lower borrowing costs.

Moreover, corporate bond spreads are beginning to widen, indicating that the market is starting to price in slower economic growth. If corporate earnings disappoint or economic conditions worsen, the Federal Reserve could face a delicate balancing act.

The challenge will be to stimulate growth without reigniting inflation, which could be exacerbated by any significant monetary easing. Thus, while inflation might remain under control in the near term, the risk of its resurgence cannot be entirely dismissed, especially if economic conditions require a more accommodative monetary policy in the coming months.

This uncertain economic outlook and potential shift in Federal Reserve policy could lead to increased volatility in the EUR/USD exchange rate. If U.S. economic growth slows and the Fed pivots toward rate cuts, the euro may strengthen against the dollar.

EUR/USD Strengthens Near Inflection Area

While the U.S. economy is at a tipping point, the EUR/USD pair is also trading at an inflection point from a technical perspective. The daily chart of EUR/USD below shows that the price has broken the inflection area by breaking the triangle formation. However, observations from the monthly and weekly charts confirm that this breakout area is broad, and the breakout is still not confirmed.

The rebound from lower levels has produced bullish price structures, indicating that EUR/USD is likely to break higher. The RSI indicator shows that the price remains within a wide range, suggesting it could correct lower again. It is also possible that the market is waiting for the Fed’s decision in September to determine the next direction. However, economic uncertainty has caused strong volatility in the pair.

The same triangle is clearly observed in the weekly chart, showing that the inflection area has not yet been broken, and the price is struggling around this region, awaiting a breakout. The inverted head and shoulders pattern highlighted in the chart below indicates a higher possibility of a breakout. However, a two-week close above 1.105 is required to confirm a breakout. This close would mark the highest weekly close since July 2023. The rising RSI above the mid-level also suggests a breakout is possible, with the pair struggling to move higher.

The EUR/USD chart above is the exact inverse of the USD market, as seen in the triangle formation in the chart below. Since EUR/USD is trading at an inflection point, the USD index is similar. A breakdown in the USD index could trigger a strong surge in EUR/USD, breaking out from its inflection area.

Long-Term Outlook for EUR/USD Stays Bullish

Despite the short-term discussion on the EUR/USD pair, the long-term direction remains bullish, with the pair likely aiming for higher prices, at least to the boundary of the falling wedge. Interestingly, in the monthly chart, the triangle observed in the weekly and daily charts resembles a bullish pennant. Moreover, the monthly candle for August is also at an inflection point. If EUR/USD closes above 1.105 in August 2024, it will be considered a breakout, with the price likely targeting the $1.1276 to $1.14 region.

The falling wedge suggests a strong bullish outlook, and if the price breaks $1.14 monthly, it could trigger a strong rally in the pair, marking a significant breakdown in the USD. The bullish pennant before the falling wedge indicates a price compression scenario, further increasing the likelihood of a breakout. This could potentially develop during the 2024 U.S. presidential election.

The short-term chart below shows significant spikes as the market trades at a critical juncture. However, the overall trend remains upward, with the market poised for further gains. Any correction in the pair is considered a strong buying opportunity.

Bottom Line

In conclusion, the EUR/USD exchange rate is at a critical juncture, shaped by a complex interplay of economic data, inflation trends, and expectations surrounding Federal Reserve policy. While recent signs of easing inflation and potential Fed rate cuts could weaken the USD and bolster the euro, stronger U.S. economic indicators and market uncertainty introduce significant volatility. The EUR/USD remains poised for substantial movements as the market navigates these conflicting signals.

The emergence of a falling wedge on the monthly chart highlights the long-term bullish bias. Additionally, the appearance of a bullish pennant within the falling wedge suggests a continuation of the bullish trend in the pair. This bullish pennant indicates an inflection level on the weekly and daily charts, with weekly closes above $1.105 potentially initiating a strong rally. Investors and traders may continue to monitor current fluctuations before making any investment decisions.