Recovery in the euro rate against the dollar suggests a possible inflection point for the currency market

  • EUR/USD recovery, a possible inflection point for the market
  • As the Fed’s interest rate speed limit may have been reached
  • ECB plans to tackle terrain on interest rates
  • Amid signs, Fed policy is already having the intended effect

Image © European Union – European Parliament, reproduced under CC licence.

The euro-to-dollar exchange rate reversed half of its July decline in a rally that could be an early warning of a market inflection point that would likely relieve many currencies of the recent relentless dollar advance. .

Europe’s single currency remained buoyant near the 1.02 level against a weaker dollar on Wednesday after previously grabbing headlines when Retuers and Bloomberg News reported that this Thursday could lead to an outsized rise in US interest rates. European Central Bank (ECB).

“Chief Economist Philip Lane would make the official proposal at the meeting, and markets are now trying to gauge how many members of the Governing Council would be happy to support such a move,” said Chris Turner, global head of markets. and regional manager. of research at ING.

“Our view remains that even in the event of a hawkish surprise, getting the euro (from a broad perspective) sustainably higher remains a difficult task given the deteriorating growth outlook for Europe,” warned Wednesday Turner and his colleagues.

Reports suggest the ECB will consider on Thursday immediately ending the era of negative interest rates in Europe by raising its three cost-of-borrowing benchmarks by 0.50%, which would bring the deposit rate down to zero. commercial banks currently negative.

Above: The Euro/Dollar exchange rate displayed at 15-minute intervals alongside EUR/GBP.

Any 0.50% rate hike on Thursday would be larger than the 0.25% move that was all but pre-agreed by the Governing Council in June and could therefore be more effective in limiting the extent to which the ECB risks to fall further behind the Federal Reserve. (Fed).

But the euro-to-dollar exchange rate had already tested the 1.02 handle on Monday after erasing nearly half of its July decline in trading sessions following Wednesday’s US inflation figures. last, which also have important implications for the EUR/USD outlook.

“At the moment, futures markets are only pricing around 81 basis points for the July meeting. These reduced expectations are also keeping the upside potential for 10-year U.S. Treasury yields and the downside potential in check. decline in EUR/USD,” says Philip Marey, senior US strategist at Rabobank.

Last week’s U.S. inflation data was grim for its reveal of a new high of 9.1% for the annual rate and a further acceleration in the core inflation rate in monthly terms, but officials Fed officials were quick to pour cold water on the idea that this might justify a faster pace of interest rate hikes.

“Price developments may have naturally spooked them, with the frontloading of rate hikes now seeming to have a cost,” says Jonathan Cohn, interest rate trading strategist at Credit Suisse.

“The perverse nature of frontloading amid fears of recession means that expectations of faster rises often increase fears of excessive tightening, depressing longer-term yields, which, on the net, eases financial conditions. “, he added.

Above: The exchange rate between the euro and the dollar displayed at hourly intervals alongside the US dollar index.

Cold water was poured as three members of the Fed’s rate-setting committee were quick to suggest that the existing plan to hike rates to moderately restrictive levels in increments of just 0.5% or 0.75% was always the most appropriate.

“The problem for the Fed is that inflationary pressures are going to be very sticky (most of the impetus now is with services which tend to be less sensitive to discrete rate moves), which means the path back to 2% will be long and drawn,” says Bipan Rai, North American head of currency strategy at CIBC Capital Markets.

The latest comments from Fed officials lowered market expectations for US rates and this adjustment was later reinforced when a survey from the University of Michigan showed consumers’ long-term inflation expectations falling. in July.

This is all the more remarkable given that central banks believe that inflation expectations are self-fulfilling prophecies, and that lower inflation rates are exactly what many of them are trying to achieve through of their interest rate policies.

“A 100 basis point hike will be discussed but we think the committee will be reluctant to pick up the pace,” said Jonathan Millar, deputy chief economist at Barclays, referring to next week’s Fed meeting.

But other recent developments have further suggested that the Fed may be right to be more circumspect than the market about accelerating the pace at which it raises interest rates so soon after doing just that already in June.

Above: Euro to dollar exchange rate shown at daily intervals alongside the US dollar index and NZD/USD.

These include a growing list of major US corporations and captains of global industries increasingly ditching their hiring plans in favor of hiring freezes.

This is exactly what the Fed hoped to achieve.

“You basically have two job offers for every person actively looking for work, which has led to a real imbalance in wage negotiations. You could get to a place where that ratio was at a more normal level,” Fed Chairman Jerome Powell said at the June press conference.

“You would expect to see these wage pressures come down to a level where people are still getting healthy wage increases, real wage increases, but at a level consistent with 2% inflation,” he added.

While the hiring freezes could yet turn into layoffs, they are also evidence of the widely coveted “soft landing” of an economy and labor market where imbalances in supply and demand have exacerbated the inflationary shock resulting from the prices of energy and internationally traded goods.

This is a materially important context in which future Fed decisions will be made and these in turn are likely to have material influences on the euro, dollar and many other currencies over the coming months. weeks and months to come.

Above: Euro to dollar exchange rate shown at weekly intervals alongside the US dollar index.

“Our objective, in reality, is to bring inflation down to 2% while the labor market remains solid. I think what’s becoming clearer is that many factors beyond our control are going to play a very big role in deciding whether or not this is possible,” President Powell also said.

“There I am thinking, of course, of the prices of raw materials, the war in Ukraine, the supply chain [developments], things like that, where we really… monetary policy stance doesn’t affect those things. But that said, we have a path to get there,” he added in response to a question from the Financial Times.

Most notably, and in short, the latest remarks from Fed policymakers suggest that the bank may have reached its interest rate speed limit for the time being, and just as the ECB plans to get going by raising its own rates for the first time this Thursday.

Meanwhile, the dollar has corrected lower against many currencies for nearly five straight trading days and Europe’s single currency has climbed smartly, while other developments suggest that rate policy decisions interest rates from the Fed may already be having the desired effect on the economy.

Analysts would likely disagree at this point, as most hold bullish views on the dollar and bearish outlook for the euro, but recent price action is supported by interest rate and market developments. inflation which all indicate that a possible inflection point is near for the foreign exchange market.

About Ruben V. Albin

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