FX.co ★ EUR/USD outlook: Dollar may fall into bullish trap

Today's focus is on crucial economic indicators and events that could significantly impact the financial markets. The spotlight is on the US GDP data for the fourth quarter, providing insights into the country's economic performance. Additionally, preliminary statistics on the trade balance for goods and speeches by influential Fed representatives - Bostic, Collins, and Williams - are on the agenda.

In the Eurozone, the economic sentiment index for February has been released, offering a comprehensive view of the current economic climate in the region. Looking ahead to the end of February, a meeting of finance ministers and central bank governors from G20 countries is scheduled for the 28th and 29th. This gathering will bring together global financial leaders to discuss key economic issues that could impact financial markets.

On Thursday, attention will shift to the core US Personal Consumption Expenditures (PCE) price index, a pivotal measure for assessing inflation. Traders will carefully analyze this data to formulate potential trading strategies as the dollar index fluctuates.

In Wednesday's trading, the dollar index regained control at 104.0, despite weak industrial orders data in the United States. Traders are eagerly anticipating new information on inflation, which could hint at the Federal Reserve's possible timeline for interest rate adjustments.

The unexpected drop in US consumer confidence to 106.7 points in February, contrary to the expected rise to 115.0, has limited the dollar's strengthening. Additionally, statistics reveal a record monthly decline in new orders for durable goods in January, down 6.1% from December, surpassing analysts' expectations of a 4.5% decline.

Bloomberg economists have revised their forecast for US economic growth in 2024 to 2.1%, reducing the likelihood of a recession to 40%. The US economic growth rate, updated on Wednesday, showed a year-on-year increase of 3.2% in the fourth quarter, slightly lower than the 3.3% advance estimate, with the downward revision attributed to rising private sector inventories.

The dollar retreated from its intraday high following mixed second US GDP data, emphasizing the market's sensitivity to economic indicators and the potential impact on currency valuations.

Technical outlook

The dollar index surged, catching some bearish investors off guard. Despite this, the path to a substantial recovery appears challenging, given the hurdles posed by the latest US GDP data and its components.

The Federal Reserve, led by Jerome Powell, has consistently emphasized its reliance on economic data. Presently, the data suggests a potential need for further rate hikes, a development conflicting with market expectations. This discrepancy may cool sentiment as the Fed evaluates the extent of potential disappointment.

Examining the technical landscape, the 100-day simple moving average (SMA) near 104.00 has been tested, with its resistance being overcome. However, there is a looming risk of a bull trap formation.

A breakthrough at 104.60 for the USD would pave the way to the next significant resistance levels at 105.12, followed by 105.88. Looking ahead, a shift in market expectations for a delayed Fed rate cut until late 2024 could bring the 2023 high at 107.20 back into relevance.

In the face of sustained selling pressure, support may weaken, potentially leading to further declines to 103.16, marked by the 55-day SMA, before testing the crucial level of 103.00. Monitoring these technical and fundamental factors is essential for a comprehensive assessment of the dollar's trajectory in the current market environment.

In recent developments, it's notable that negotiations in the US Congress aimed at preventing a government shutdown and providing assistance to Ukraine, Israel, and Taiwan did not yield an agreement between Republicans and Democrats. The potential for a government shutdown looms, which could trigger a decline in risk asset markets while bolstering the position of the dollar.

Market sentiment is also influenced by the anticipated likelihood of a 25 basis point Fed rate cut to 3% at the March meeting, with a 21% chance of a similar decision at the April-May meeting.

On the international front, Germany, France, and Spain are set to report inflation data on Thursday, preceding eurozone statistics scheduled for Friday. ECB officials remain cautious about rapidly easing monetary policy in the eurozone. Christine Lagarde highlighted stable wage growth in the region, and Yiannis Stournaras from the ECB's executive board ruled out interest rate cuts before June.

In Germany, the GfK consumer sentiment index continues to show negative readings, reaching -29.0 in February compared to -29.6 in January. German citizens persist in viewing cost-saving as a prudent strategy in the face of rising prices and more pessimistic forecasts for the national economy this year.

Furthermore, lending to households in the eurozone recorded a mere 0.3% year-on-year growth in January, marking the slowest pace since March 2015. This underscores a notable deceleration in economic activity in the eurozone amid ECB rate hikes. Monitoring these diverse factors provides a comprehensive understanding of the dynamic forces shaping the current economic landscape.

Euro's weakness

The EUR/USD pair declined to the psychological level of 1.0800 amid the dollar's uptrend and deterioration of the consumer sentiment in the euro zone. These signals indicate that the euro's recovery cycle may be completed.

The preceding day saw the currency pair reaching its peak at 1.0866, only to experience a subsequent decline to 1.0813, triggered by a dip in the European Commission's Economic Sentiment Index (ESI) for February to -9.5. This was against the forecast of -9.2 and the previous value of -9.3.

The eurozone economy continues to grapple with challenges, and the decrease in economic sentiment indicators suggests that risks lean towards further deterioration in the short term.

Although the euro has exhibited growth against the dollar since mid-February, primarily driven by the dollar's weakening due to early-year economic slowdown, the latest sentiment data emphasizes the challenging economic environment in the eurozone. This points to ongoing difficulties that may constrain the euro's potential for recovery.

There is speculation that the ECB might opt for an interest rate cut earlier than June, which could limit the euro's growth prospects. Scotiabank observes a weakening of the euro around the 1.0850 mark, reinforcing bearish sentiment on short-term charts. A rebound above the 1.0835 resistance level could alleviate pressure on the euro, potentially guiding it towards higher ground around 1.0800.

As the month concludes, additional pressure on the dollar is anticipated, confirming the technical nature of the recent dollar weakening rather than a shift in the fundamental trend, according to experts.

Despite recent fluctuations, the prevailing trend suggests the dollar's upward trajectory. The dollar's downward trend is expected to be short-lived, considering the outperformance of the US economy and bond yields near three-month highs, which make the greenback appealing.

Moreover, the Federal Reserve is not likely to implement interest rate cuts anytime soon, especially given the more accommodative policies pursued by other major central banks globally. Stronger-than-expected data from the US and the cautious stance of Fed officials against premature policy easing contribute to the likelihood of a revision in market expectations, potentially leading to further gains for the dollar following the ongoing consolidation period.