Last week, the market strengthened its confidence that the Fed will raise interest rates by 25 basis points next month. At the moment, the probability of this scenario is 86% (according to CME FedWatch Tool). A week ago, traders estimated the odds of a rate hike in May as 50/50, but rising core inflation in the U.S. has tipped the scales in favor of the hawkish scenario.
According to many currency strategists, a strong decline in overall inflation and weak macroeconomic reports (ISM indices, retail sales) would not prevent the U.S. regulator from holding another round of rate hikes. But this round is likely to be the last in the current cycle of monetary policy tightening. This circumstance does not allow dollar bulls to show their full strength: despite the growth of hawkish expectations, the greenback remains under background pressure, including in a pair with the euro.
7-week Journey Upward
The EUR/USD pair updated its yearly price high last week, hitting 1.1076. The last time the pair was in this price range was in March 2022. However, EUR/USD buyers failed to conquer the 11th figure—the upward momentum faded upon approaching the 1.1100 resistance level. The notorious "Friday factor," unexpected growth of industrial production in the USA, and the hawkish statement of the Fed representative Christopher Waller allowed the sellers to intercept the initiative in the pair. As a result, the previous trading week closed within the 9th figure.
At the start of the new week, the initiative changes hands. Against the backdrop of Monday's almost empty economic calendar (among the important events are only the release of the Empire State Manufacturing Survey and Lagarde's ceremonial speech in New York), the price of EUR/USD shows mixed dynamics.
Looking at the weekly chart, we see that the pair has been within the pronounced upward trend since the beginning of March, that is, for the seventh week in a row. The "black swan" in the form of a snowfall in the United States, which occurred last month, forced the Federal Reserve to reconsider its aggressive policy. Recall that just a few days before the collapse of the SVB, Fed Chairman Jerome Powell, speaking in Congress, said that the final level of the interest rate is likely to be higher than previously assumed. He also stated the possible need to raise the rate more sharply. But the crisis in the banking sector has softened the position of the Federal Reserve. Actually, this fact served as a starting point for the development of the upward trend, within which the pair strengthened by more than 500 points.
Current price fluctuations should be viewed through the prism of March events. After all, by and large, the engine of EUR/USD growth is the possible uncorrelation of the Fed and ECB rates. The likely May rate hike by the Fed will apparently be the last in the current tightening cycle of monetary policy (as evidenced, in particular, by the updated median forecast), while the European Central Bank does not intend to deviate from the hawkish path in the coming months.
For example, according to most economists surveyed by Bloomberg, the European regulator will raise the rates at least at the next three meetings—in May, June and July. Having reached 3.75% (deposit rates) in mid-summer, the ECB may take a break to evaluate the effectiveness of its measures (the main focus will be on the dynamics of core inflation). In this case, most of the economists interviewed expressed confidence that the regulator will keep rates at their current levels at least until the end of this year.
As for the pace of tightening, experts agree on a 25-point increase in May. However, there is an active discussion on this matter, including among ECB members. For example, National Bank of Belgium Governor Pierre Wunsch said last week that the regulator will choose between a 25 or 50 basis points rate hike. He clarified that the size of the step "depends largely on April's core inflation." A similar position was voiced today by Governing Council member Martins Kazaks. In favor of a 50-point increase in May were, in particular, the head of the Central Bank of Slovenia, Bostjan Vasle, and the head of the Central Bank of Austria, Robert Holzmann.
Greenback strengthening: growth "in spite of"
After Friday's sharp decline, the EUR/USD pair entered a consolidation phase. The downward impulse was due to the inability of the pair's buyers to consolidate in the area of annual highs, that is, at the borders of the 11th figure. But the current growth of the greenback is a growth "in spite of," not due to objective circumstances. Support for the dollar was provided by "hawk" Christopher Waller, who said on Friday that the Fed had not made significant progress in achieving its inflation target, so "the rate needs to be raised further." The dollar reacted positively to this statement, but this reaction may be short-term.
The Fed's 25-point rate hike in May is already partly priced in, while further tightening prospects are highly questionable given the side effects of the Fed's aggressive policy (March bank failure, weak ISM reports, failing retail sales report, conflicting Nonfarm payrolls, etc.).
At the same time, representatives of the ECB demonstrate a consolidated hawkish position, which implies several increases in the current year (according to Bloomberg estimates, at least three increases).
Conclusions
The current fundamental background for the EUR/USD pair does not contribute to the development of the downward trend, so the current price pullback is corrective in nature. In the medium term, long positions are still a priority for the pair.
This is also evidenced by the technical analysis: on the daily chart, the price is located between the middle and upper lines of the Bollinger Bands indicator, as well as above all the lines of the Ichimoku indicator (including the Kumo cloud). The nearest support level is 1.0950 (Tenkan-sen line on the D1 timeframe). The target of the upward movement is 1.1040 (the upper line of the Bollinger Bands), overcoming which will open the way to the main price barrier 1.1100.