"The Fed enjoyed a nice soft print that it can hang its hat on. But this is also why the USD is struggling temporarily and why EUR, GBP continue to outperform" - Jefferies.

Image © European Central Bank

The Euro to Dollar exchange rate reached its highest level since March last year in the penultimate session of the week but the rally could be at risk of coming undone in the days or weeks ahead if government bond yields, international stock markets and the current trajectory of the gold price are anything to go by.

Europe's single currency built further on its midweek rally above the 1.11 level on Thursday as the Dollar sold off almost across the board while stock markets, government bonds and commodity prices rallied following Wednesday's decline of U.S. inflation rates for last month.

Inflation fell back to 3% in the U.S. last month as the core inflation rate dipped to 4.8% in its first foray below the 5% handle since late in 2021, leading to losses for U.S. and other government bond yields while also bolstering stock markets that had sustained heavy losses as interest rates rose last year.

"Since 2003, EUR/USD volatility has increased this month in 75% of the years," says Kit Juckes, chief FX strategist at Societe Generale.

"Even if history is not bound to repeat, investors should not neglect this seasonal effect, especially in an environment where volatility remains under selling pressure and with the imminent threat of thinner summer liquidity," Juckes says.

Above: Euro to Dollar rate shown at daily intervals shown alongside S&P 500 index futures (yellow), gold price and the spread or gap between 02-year German and U.S. government bond yields.

Wednesday's data brought the Federal Reserve to within reach of its two percent average inflation target less than a week after the non-farm payrolls report for June suggested employment growth moderated last month, suggesting solid progress by Federal Open Market Committee members in achieving their objectives.

Reducing employment and wage growth sufficiently to keep inflation from rising further has been a key objective of the Federal Reserve and the latest data was indicative of it doing that, though it remains to be seen how much longer these inflation and employment trends last for. , in light of price action in financial markets

"The Fed enjoyed a nice soft print that it can hang its hat on. But this is also why the USD is struggling temporarily and why EUR, GBP continue to outperform," writes Brad Bechtel, global head of FX at Jefferies.

"Where the EUR and GBP are right now, just don't make a lot of sense against the USD, JPY, AUD, CAD or on a broad measure like TWI. Can't fight the tape on this, so I am not short EUR and GBP just yet," he adds in a Thursday market commentary.

Rising stock markets and the rallying Euro have left falling bond yields in their wake while also loosening financial conditions and providing stimulus to economies in Europe and beyond, though these developments come with risks that could eventually lead them to become self-defeating.

This is because loosening financial conditions and fresh stimulus for economies will risk prolonging inflation at above-target levels for even longer while potentially also leading to additional increases in interest rates further down the line, and in one way this is what the rallying gold price might be warning of.

Above: Euro to Dollar rate shown at daily weekly intervals with Fibonacci retracements of 2021 and 2022 downtrends indicating possible areas of technical resistance while selected moving averages denote possible support and/or resistance for the single currency.

"The currency of any nation acts a bit like the equity of the government - helping as a shock absorber to policy mistakes and rewarding successes," says Bob Savage, head of markets strategy and insights at BNY Mellon.

"That is the problem of the present push down in the USD as the FOMC success in getting inflation back on track to meet forecasts and anchor expectations has not been rewarded," Savage writes in a Thursday market commentary.

The U.S. Dollar has long tended to be negatively correlated with gold but some in and around the market also view the precious metal as a protective 'hedge' against inflation and if the latter is what's driving the price higher, it might be indicative of financial conditions being close to having loosened as much as they're likely to.

But that would also suggest the Euro is close to peaking, meaning it might struggle to sustain itself above the nearby 200-week moving average at 1.1181:

The author's own inflation-based valuation model, however, suggests that 'fair value' currently resides somewhere between 1.0614 and 1.1381 with an average of 1.1075: The 'spot inflation' component of the model places 'fair value' at 1.1232.