EUR/USD recovery aided by multiple tailwindsBut resistance looming overhead from 1.0746+ CPI data, ECB, China & USD key for recoveryU.S. PMI surveys, jobs, Fed also key for USD

Above: Terminal, Shanghai, China. Image © Adobe Stock

The Euro to Dollar rate has been lifted by hawkish escalation of European Central Bank (ECB) policy chatter and favourable international tailwinds but will likely require the ongoing support of both this week if it’s to overcome technical resistance looming immediately overhead of the market.

Europe’s single currency was lifted further last week, marking its first back-to-back set of weekly gains since the earliest days of the second quarter last year after China took steps to ease coronavirus-related restrictions in Shanghai and as ECB policymakers signalled a more hawkish policy stance.

Provisions were made for Shanghai’s reopening to progress further at the weekend while restrictions on activity were also reportedly relaxed in the Chinese capital Beijing, which matters for the Euro-Dollar rate given the extent of the losses it sustained since the latest ‘lockdown’ in early April.

Europe’s single currency fell from around 1.10 to a low of 1.0349 between the opening of April and middle of May and a meaningful portion this decline was driven by developments in China and price action in Renminbi exchange rates.

“The bounce in EUR/USD is very notable and is becoming more difficult to simply dismiss out of hand as just a temporary reversal,” says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

Above: Euro to Dollar rate shown at daily intervals with Fibonacci retracements of February decline and various extensions thereof indicating likely technical resistances to any further recovery. Click image for closer inspection.

“While EUR/USD could drift lower again there are factors to suggest better support for EUR/USD is emerging. We remain sceptical of parity being hit,” Halpenny and colleagues said on Friday.

Anything that supports a Chinese economic recovery or normalisation of the country’s foreign trade is noteworthy for the Eurozone given that 10% of the bloc's exports went to the world’s second largest economy in 2021, which was also the source of 21% of Eurozone imports.

However, the broad Dollar trend and ECB monetary policy are also key influences, and each of these will potentially be responsive on Tuesday when Eurostat releases its estimate of Eurozone inflation in May, which the market expects to rise from 7.5% to a new record of 7.7%.

“We’re of the view that the next shock to inflation will come from strong services, which will push up core inflation and may lead to more members of the ECB toying with 50bp in July,” says Jordan Rochester, an FX strategist at Nomura, and European Economics colleague George Buckley.

“The market credibly pricing in 50bp rate hikes for the euro area is a big risk for EUR shorts,” they wrote in a research briefing on Friday.

Rochester and Nomura colleagues doubt the ECB would actually lift Eurozone interest rates by a larger than usual increment of 0.5% in July, which would end the era of negative interest rates in Europe, but they’ve noted the risk of markets speculating in this direction over the coming weeks.

This is all after multiple members of the ECB Governing Council including President Christine Lagarde and chief economist Philip Lane expressed support for an increase in borrowing costs that could end the era of negative interest rates in Europe at any point before year-end.

So-called ‘dovish’ policymakers are now a rarity in the Governing Council of the ECB while what it means to be a moderate voice has also now shifted in favour of rising Eurozone interest rates in what is a highly supportive development for the Euro-Dollar rate.

But for the single currency to extend its recovery through the week ahead it’s possible that an upside surprise in Tuesday’s inflation figures and more speculation about the prospect of an outsized 0.50% increase in the deposit rate could be necessary.

Above: U.S. Dollar Index shown at weekly intervals with Fibonacci retracements of June 2021 rally indicating possible areas of technical support.

This is all unless the recently retreating U.S. Dollar continues to recede from the almost two decade highs reached earlier in May for reasons relating to the Federal Reserve (Fed) policy outlook, or some other factor.

“EUR/USD can lift this week because of USD weakness and the resilient Eurozone economy. Upside resistance at 1.0799 could easily be tested. The CPI for May (Tuesday), the unemployment rate for April (Wednesday) and retail sales (Friday) are the Eurozone highlights this week,” says Joseph Capurso, head of international economics at Commonwealth Bank of Australia.

“Were it not for China’s covid lockdown, the global economic outlook would be brighter, and the USD would be even lower in our view. This week’s key global economic data will be mixed in our view. We expect China’s PMI to remain very weak in May, even if the indices do not fall further. We expect the US ISM to weaken again, albeit to solid levels. We estimate US non-farm payrolls expanded strongly again in May,” Capurso also said on Monday.

Last week the Dollar softened amid signs that significant parts of China’s economy may be emerging from a coronavirus-induced hibernation and after some U.S. economic data including figures relating to the services sector, housing market and business investment pointed to a softening economy.

These figures encouraged speculation about a possible slowdown in the pace at which the Fed is likely to lift its interest rate later in the year.

This week the Dollar’s attention will be on data including Institute for Supply Management (ISM) PMI surveys and the Bureau of Labor Statistics' Job Openings and Labor Turnover Survey (JOLTS) on Wednesday, which come ahead of Friday’s non-farm payrolls report for the month of May.