The EUR/USD pair concluded the trading week at the 1.0700 level. This target symbolically reflects the current situation. On one hand, the EUR/USD bears have managed to settle within the 7-figure range, demonstrating a downtrend. On the other hand, they haven't been able to break the 6-figure threshold, despite their attempts. The 1.0700 level represents a critical juncture: either the pair will consolidate below this level, or it will go through a corrective phase towards the 8-figure range.
In general, the fundamental backdrop favors the US dollar and, consequently, the bears. The past week saw a rise in risk-off sentiment due to underwhelming China macro data, as well as a rise in inflation expectations, thereby strengthening the hawkish sentiment regarding the Federal Reserve's future course of actions. In addition, relatively positive economic reports provided additional support to the dollar. In contrast, the euro faced pressure from its own economic reports. For instance, the second estimate of eurozone GDP was unexpectedly revised downwards: according to the revised data, the region's economy grew by only 0.1% quarter-on-quarter in the second quarter (initial estimate was 0.3%). On an annual basis, the figure was also revised lower (0.5% year-on-year instead of 0.6%).
However, the primary driver of the downtrend was the dollar itself. The weak euro played a secondary, or rather, a supportive role. If we were to discuss the "hierarchy" of the significance of fundamental factors, in my opinion, it can be summarized as follows: growing risk-off sentiment, rising oil prices, hawkish signals from the Fed, and economic reports. Let's delve into these informational drivers in more detail.
The increased interest in safe-haven assets, especially the dollar, is driven by a recurring message that is being increasingly echoed from various sources: China will slow down the global GDP. Such concerns were voiced by many analysts as early as summer, but this issue has become more relevant recently. According to some experts, China's slowdown marks the beginning of an economic crisis in the country. Many point to structural problems exacerbating the situation (such as a significant rise in youth unemployment). During August, major financial conglomerates like Morgan Stanley, Barclays, UBS, and Nomura all revised their forecasts for China's economy downward. Among the primary reasons are problems in the real estate sector (with a special nod to Evergrande), a high level of government, corporate, and household debt, as well as insufficient actions by Chinese officials to revive the national economy.
Recent macroeconomic reports (weak PMIs, disappointing foreign trade data, and a decline in industrial output) as well as the devaluation of the yuan only add fuel to the fire. In the context of the EUR/USD pair, there's another important nuance related to the "China factor." According to some analysts, the Chinese economic downturn, which will affect global economic growth, will force members of the European Central Bank to lower interest rates next year. Experts point out the more stable positions of the U.S. economy, allowing the Fed to keep interest rates "as long as necessary." The anticipated divergence in central bank actions puts more pressure on the EUR/USD pair. In this case, the greenback stands out more favorably, not only against the euro but also, for instance, against the Australian dollar or the pound. However, in the case of the EUR/USD pair, this aspect is more pronounced.
Hawkish expectations regarding the Fed's future course of actions are gradually on the rise. But the focus here is not on September, but on November. According to the CME FedWatch Tool, the probability of a rate hike in September is 8%, while in November, it's almost 50%. In my opinion, the prospects for a November hike (the Fed does not hold a meeting in October) will depend on the dynamics of inflation indicators for August and September. If inflation in the U.S. accelerates (especially the core CPI and the core PCE index), the probability of an additional 25-point rate hike will jump to 80%.
There are certain prerequisites for the realization of this scenario. Market participants have not reacted without reason to the spike in oil prices last week. The price of a barrel of Brent crude oil rose to $90, driven by news of additional supply cuts from major oil-producing countries such as Russia and Saudi Arabia. Russia announced that it would reduce its exports by 300,000 barrels per day in September (following a 500,000-barrel reduction in August). Saudi Arabia will extend its voluntary oil production cut of 1 million barrels per day until the end of 2023. In essence, this means a supply deficit in the market until the end of the current year, with all the resulting consequences (reduction in global inventories and higher oil prices). Obviously, rising oil prices will likely have an effect on the dynamics of inflation in the United States, triggering a response from the Fed. As mentioned earlier, the probability of a rate hike in November has now risen to nearly 50%. Notably, the market currently assigns a 40% probability of a rate hike to 5.75% at the December meeting (assuming a 25-point hike in November). In other words, the market is considering one or two rounds of rate hikes this year, providing strong support for the U.S. dollar.
Furthermore, the latest economic reports from the United States allow dollar bulls to be more assertive. In particular, the ISM Business Activity Index for the services sector in August came in at 54.5 points (against a forecast of a rise to 52 points). This is the best result since February. In addition, manufacturing expenses paid by these businesses have increased. The previously published ISM Manufacturing Index also entered the "green zone", rising to 47.6 (the best result since February).
The labor market was another indicator that was in the green zone. For example, the initial jobless claims figure increased by only 216,000 in a week. This is the best result since March. Most importantly, this indicator has been consistently decreasing for the fourth consecutive week.
Thus, the fundamental background for the EUR/USD pair supports its further decline. Of course, the ECB could play the role of a "black swan" here, as it will hold its meeting. However, excluding this "uncertainty" from the equation, one can conclude that the bearish scenario for the EUR/USD pair looks more promising than the bullish one. If sellers push below the support level of 1.0700 (the lower Bollinger Bands line on the daily chart), the next target for the downward movement will be 1.0620, which is the lower Bollinger Bands line on the weekly chart.