The EUR/USD pair found itself in a turbulent area following the release of important macro data. Bears tried to pull the price below the target of 1.0960 (the middle line of the Bollinger Bands indicator on the daily chart), while bulls, in turn, tried to approach the resistance level of 1.1070 (the upper line of Bollinger Bands on the same chart). Bears and bulls alternately pulled the rope to their side, but the situation remains the same: the pair showed increased volatility, but actually stood still, trading within the range of 1.0960-1.1070. Such a situation is explained by the contradictory fundamental background that has developed for the pair. The key macro data that were published on Thursday and Friday left more questions than answers. The complex puzzle was further complicated by another unexpected factor – the possible collapse of another American bank. However, let's discuss everything in order.
US GDP and core PCE index
The dollar reacted positively to the US GDP report, despite the fact that it was in the "red". US GDP volume increased by only 1.1% in the first quarter, while most experts expected to see a 2% growth rate. However, the inflationary components of the report were on the side of the greenback. The core GDP price deflator in the first quarter was in the "green", rising by 4.9% year-on-year, with a forecasted growth of 4.7% y/y. Consumer spending jumped by 3.7% (the highest growth rate since the second quarter of 2021).
Such dynamics of inflationary components strengthened traders' confidence that the Federal Reserve will decide on another 25-point rate hike at the May meeting. However, the day before the release, the probability of implementing this scenario dropped to almost 50% (according to data from the CME FedWatch Tool) due to problems with First Republic Bank. The collapse of this bank's shares alarmed market participants, as it could follow the fate of Silicon Valley Bank, Signature Bank, and Silvergate.
Nevertheless, following this report, the chances of a rate hike in May increased to 80%. After Friday's report, the probability of implementing this scenario is now estimated at almost 90%. We are talking about the core Personal Consumption Expenditures (PCE) price index in the US. As you know, this inflation indicator is closely monitored by the Fed, so the market pays close attention to it. Year-on-year, the indicator dropped to 4.6% with a forecast decline to 4.5%. The "green tint" of this report supported the dollar, although, by and large, the report reflected a decrease in the indicator. From September to December last year, the index consistently declined - from 5.2% to 4.6%. Then, in January and February, the indicator stood at 4.7%, and in March, it returned to the December level of 4.6%.
Overall, the aforementioned reports suggest that the Fed will decide on another step to tighten monetary policy. Recall that the updated median forecast in March also assumed another 25-point increase by the end of the year. However, these reports are unlikely to strengthen the central bank's hawkish sentiment, especially in the face of problems with First Republic Bank. According to Reuters, US regulators are currently negotiating to save the bank, which is on the verge of bankruptcy. According to insider information, government negotiations are now focused on preparing to transfer First Republic under the control of the FDIC (Federal Deposit Insurance Corporation). Meanwhile, First Republic's shares collapsed by 30% (to $4.31) on Friday, and since March, with the beginning of the banking crisis in the US, the bank's shares have lost 95% of their value.
Such an information background does not contribute to strengthening the hawkish sentiment of the Fed, so the dollar could not hold the positions it had occupied and weakened across the market at the end of the trading week.
Eurozone GDP and German inflation
Despite the general weakening of the greenback, EUR/USD bulls could not take advantage of the situation. The pair remained within the aforementioned price range, ending the trading week at the 1.1018 mark. The fact is that important macro data were also published in Europe, which also left many questions. In the first quarter of 2023, the eurozone GDP grew by 0.1% quarter-on-quarter, which was below the expected growth of 0.2%. Year-on-year, the indicator increased to 1.3% with a growth forecast to 1.4%. The highest growth compared to the previous quarter was recorded in Portugal, Spain, Italy, and Latvia. A downtrend was recorded in Ireland (-2.7% q/q) and Austria (-0.3%).
On one hand, the indicator ended up in the "red," falling short of the forecasted level. On the other hand, the eurozone effectively avoided a recession, starting the year with GDP growth. Moreover, the structure of the report indicates that consumer price growth has accelerated in France and Spain.
Speaking of inflation, another important report influenced the dynamics of the EUR/USD pair.The consumer price index in Germany, in annual terms, decreased in April to 7.2%, with a forecasted decline to 7.3%. In monthly terms, consumer prices increased by 0.4%, while experts expected a more significant growth (to 0.8%). The annual Harmonized Index of Consumer Prices (HICP), which the European Central Bank prefers to use for measuring inflation, similarly did not match forecasts. In April, it reached 7.6%, while most experts predicted growth to 7.8%.
Here again, a bundle of contradictions. On one hand, the mild winter weather and fiscal stimuli helped the eurozone avoid a recession. On the other hand, European economic growth remains weak, and the pace of declining inflation in Germany turned out to be stronger compared to most experts' forecasts (although the CPI remains at an unacceptably high level).
Conclusions
In my opinion, the key macro data published last week did not change the situation dramatically. Weak US economic growth was "compensated" by a significant increase in the GDP deflator. This combination suggests that the Fed will most likely increase the rate by 25 basis points but will not "brandish its sword" by tightening its rhetoric (plus, we must not forget the situation with First Republic Bank).
As for European reports, the situation here remains uncertain: the reports did not tip the balance in favor of a 25-point or 50-point rate hike at the May meeting. According to some experts, weak eurozone GDP growth will force the ECB to resort to a 25-point increase. But we must not forget that the core consumer price index in the eurozone reached a record high again in March, after which many representatives of the ECB spoke about the need to raise rates by 50 points immediately. If April's pan-European inflation reflects further growth of the core CPI, then weak GDP growth, in my opinion, will not be an obstacle to the implementation of the 50-point scenario.
Thus, as of "now," the situation with the pair remains uncertain. Traders could not determine the direction of the price movement amid a contradictory fundamental picture. A corresponding information trigger is needed to push the price out of the 1.0960-1.1070 range. Obviously, traders are hesitant to open large positions ahead of the Fed and the ECB's May meetings. Central banks will help EUR/USD traders solve the fundamental puzzle that has arisen.