Both the Fed and the ECB have done what the financial markets expected of them. However, unlike the U.S. central bank, the European one is still far from the end of the monetary tightening cycle. Interestingly, the result was the same—a sell-off on the facts. First, the U.S. dollar suffered, then the euro. As a result, the EUR/USD once again went on a roller coaster ride, causing more than one trader to go gray.
The Federal Reserve played its hand first. Investors were afraid that it would maintain the wording that some tightening of monetary policy would be appropriate, and Jerome Powell would mention the idea of a "dovish" reversal in 2023. In fact, everything happened differently: the phrase disappeared from the accompanying statement text, and the Fed chairman said that the markets could have their own opinion. The EUR/USD "bulls" stopped being afraid and went on the attack amid falling Treasury yields and an increased likelihood of a federal funds rate cut to 4.25% by the end of the year.
Dynamics of the assumed Fed rate
Then the serve passed to the ECB. Unlike most of the Governing Council meetings over the past 15 years, a strong euro in May turned out to be a friend of the European Central Bank. It used to worry about exports and overly low prices. Now the regulators prefer to play in reverse currency wars, where strengthening the currency unit helps them defeat inflation.
However, according to the latest ECB research, a 1% change in the euro exchange rate will reduce import prices by 0.3% over the next year. The impact on consumer prices will be even more insignificant—0.04%. That is, the 15% EUR/USD rally since October will slow down CPI by only 0.6%. And that's a piece of cake when trying to lower inflation from 7% to a target of 2%.
European inflation dynamics
Thus, the euro played on the side of the ECB, but the fact that the Governing Council did not tell the market anything new led to sell-offs on the facts. Indeed, a 25 bps increase in the deposit rate to 3.25% was already accounted for in the currency pair quotes. It needed a fresh driver to restore the upward trend, but Christine Lagarde did not provide it.
It did not help the EUR/USD that the news of stopping reinvestment of income from redeemed bonds purchased under QE from July was also expected by the markets. Perhaps even a little earlier—from June. Therefore, this news did not suit the euro.
Overall, the slowdown in the pace of monetary tightening from 50 to 25 bps suggests that the eurozone interest rate hike cycle will soon come to an end. The short-term market lowered the assumed borrowing cost ceiling from 3.9% to 3.7%, which puts pressure on the euro.
Technically, long positions on EUR/USD formed from 1.1 held up. We will increase them on the breakout of resistances in the form of the upper fair value boundary at 1.1075 and the local peak at 1.1095. However, if the quotes return to the entry level, it makes sense to flip, enter a short position and play the Three Indians reversal pattern.