EUR/USD facing resistance near 1.0249 & 1.0270At risk of deeper setback after U.S. yields rousedAs U.S. data incites hawkish Fed policy response U.S. inflation the highlight quiet week for EuropeMinor chart supports at 1.0122, 1.0081 & 1.0024

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The Euro to Dollar rate was dealt setbacks from near and afar last week but it’s the risk of a more protracted upturn in U.S. government bond yields that would threaten to push it back toward July’s lows if U.S. inflation figures further incite a still-hawkish Federal Reserve (Fed) this Wednesday.

Europe’s single currency came close to the 1.03 handle against a retreating Dollar in the opening session of last week but its attempted recovery was cut short again by seemingly growing risks to energy supplies in Germany and some other European countries.

The Russian government’s ongoing attempt at using gas supplies to coerce its way out of European sanctions over its war in Ukraine scuppered the Euro’s early attempt at recovery last week and could remain a headwind for the single currency in the days ahead.

“Rising electricity prices in Europe are making new record highs this week, and while it is odd that this alone has not pushed EUR/USD lower, it is just a matter of time, in our view. Next week, droughts in Germany may lead to the water levels on the river Rhine falling below 40cm at Kaub (the shallowest part of the river’s mid-section), making the river virtually impassable for cargo,” says Jordan Rochester, a strategist at Nomura.

Above: Euro to Dollar rate shown at hourly intervals with Fibonacci retracements of mid-July rebound indicating possible areas of short-term technical support. Click image for closer inspection.

“Around 30% of Germany’s coal, iron ore and natural gas is transported along the river, with 2018’s dry levels shaving off 0.4-0.7% of 2018’s GDP. If this happens, it would add extra delays to the supply chain but also make coal electricity production even more difficult at a time when Germany is trying to move away from Russian gas,” Rochester and colleagues warned on Friday.

It’s not just energy supply risks that have been a weight around the ankles of the Euro, however, as the message coming from the most recent U.S. economic data has also been an increasing headwind after reviving a previously stalled rally in U.S. bond yields and the Dollar last week.

This is after Institute for Supply Management PMI surveys of the U.S. manufacturing and services sectors rose for the month of July in contradiction of their gloomier S&P Global counterparts, which had suggested late last month that the all-important services sector likely contracted in July.

Meanwhile, last Friday’s non-farm payrolls report made an open mockery of the notion that the U.S. economy could be close to a recession and was all the more notable for the strong increase in average hourly wage growth, which could have implications for Federal Reserve policy outlook.

Above: Euro to Dollar rate shown at daily intervals with Fibonacci retracements of April and June declines indicating possible areas of short-term technical resistance for the Euro. Click image for closer inspection.

“Combined with signs of weaker labor supply, risks of more persistent wage and inflation pressures appear to be on the rise,” writes Pooja Sriram, an economist at Barclays, in a Friday research briefing.

“Following the solid July employment report, a 75bp hike in the September FOMC meeting remains on the table, with the likelihood of a hike of this magnitude having risen. That said, we retain our baseline outlook for a 50bp hike, given that the Fed will have a wide set of data to consider in the long inter-meeting period (~7 weeks), including the July CPI print next week and another set of employment and CPI data in September,” she added.

The Dollar had fallen with the Euro benefiting since mid-July after a run of poor economic data suggested the U.S. economy was slowing faster than anticipated by the Federal Reserve, which also indicated late last month that it would potentially slow the pace of its interest rate rises as a result.

But last week’s economic data lifted expectations for the Fed’s interest rate in September and gave a new lease of life to U.S. bond yields and the Dollar, which could rise further in the days ahead if Wednesday’s U.S. inflation figures provide further incitement to a still-hawkish Federal Reserve.

Above: Euro to Dollar rate shown at daily intervals with spread or gap between German and U.S. 02-year government bond yields. Click image for closer inspection.

“Without any important Eurozone economic data EUR/USD is likely to be driven by trends in the USD,” writes Kristina Clifton, a senior economist and currency strategist at Commonwealth Bank of Australia, in a Monday research briefing.

“We expect EUR/USD to trade below parity, more than just briefly, sooner rather than later. EUR is also likely to remain heavy against other major currencies as issues with energy supply and prices remain front of mind,” Clifton added.

Some Fed policymakers reiterated last week that U.S. interest rates are likely to top 3% or more this year and also appeared to repeatedly warn financial markets away from their recent assumption that borrowing costs could then be cut quickly and as soon as the second quarter of 2023.

But the danger is now that U.S. inflation data out on Wednesday would force markets to abandon any residual bets on 2023 rate cuts and to instead price-in more aggressive action from the Fed, which would threaten to heap further pressure onto the Euro in the second half of the week.

“We expect both headline and core inflation to remain high in the month. Continued hawkish messages from the Fed and a strong CPI result can see financial markets start to shift pricing back towards a higher peak in the Funds rate,” CBA’s Clifton says.