EUR could attempt recovery of 1.03 if USD retreats furtherWith questions emerging over transatlantic growth outlookAfter U.S. PMIs outpace Europe PMIs in July race to bottomFed decision in focus ahead of European CPI & GDP data

Image © European Commission Audiovisual Services

The Euro to Dollar exchange rate bounced resoundingly last week and could attempt to further reverse this month’s decline in the days ahead if the Federal Reserve (Fed) leaves the greenback hanging on Wednesday and all pans out well for the single currency on the European data front.

Europe’s single currency received a late lift on Friday after S&P Global PMI surveys suggested activity in the all-important U.S. services sector may have fallen even faster than in Europe’s manufacturing sector during July.

This saw the Euro-Dollar rate recover above the 1.02 handle ahead of the weekend and in price action that was indicative of a currency market asking itself whether the Euro Area economy was really all that far behind its North American counterpart in the opening month of the third quarter.

“In view of recession risks, Italy’s collapsed government and a very strong USD, the ECB has a lot of cards stacked against it,” says Jane Foley, head of FX strategy at Rabobank, writing in the wake of last week's interest rate rise from the European Central Bank.

“We have revised down our EUR/USD forecasts and see risk that the exchange rate could drop as low as 0.95 over the summer months. We expect broad-based USD strength to ebb early next year allowing EUR/USD to recover to the 1.05 area on a 6 month view,” she added.

Above: Euro to Dollar rate shown at hourly intervals. Click image for closer inspection.

While the Euro benefited on Friday from the grim message of the latest U.S. business surveys, local economists have become more pessimistic on the European economic outlook of late and analyst forecasts for the Euro-Dollar rate are increasingly bearish

“We expect the EUR to remain under downward pressure in the near-term driven by ongoing fears over disruption to the euro-zone economy from energy supply constraints and fragmentation risks,” says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

“The release of the euro-zone PMI surveys for July have further reinforced fears for a sharper slowdown/recession for the euro-zone economy in 2H of this year,” Halpenny and colleagues also said on Friday after suggesting that clients remain sellers of EUR/USD.

All of this may mean that the Euro will struggle to sustain its recent rebound without any further declines by the U.S. Dollar, which retreated broadly last week after having pushed many currencies to multi-year, if not more-than decade lows during the prior period.

That would leave a lot to be determined by this Wednesday’s Fed decision and whether its latest guidance gives the market cause to price-in a more hawkish interest rate path or if it instead leaves the Dollar hanging in suspense pending clarity on the U.S. economic outlook.

“After erratic gyrations, EUR/USD is pretty much unchanged from its pre-ECB level. I suspect we will trade a range now as we count down to the FOMC on the 27th,” says Jonathan Pierce, a currency trader at Credit Suisse.

Above: Euro to Dollar rate shown at 4-hour intervals with Fibonacci retracements of July declines indicating possible short-term technical resistances. Click image for closer inspection.

“It’s tough to clear resistance in the 1.0280/1.0300 band and support is likely once sub 1.0150. I plan to trade flexibly within these parameters, trying to monetize the range but still with a bias for selling rallies,” Pierce said in a Friday trading desk commentary.

Wednesday’s decision is widely expected to result in a second 0.75% increase that would lift the Fed Funds rate to between 2.25% and 2.5%, which is also the middle of the estimated “neutral range” in which interest rates neither stimulate nor inhibit the U.S. economy.

The Fed set itself on course in June to lift rates to a “modestly restrictive” level somewhere between 3.25% and 4% by year-end but also said its arrival at that neutral level could prompt it to reevaluate the speed at which U.S. interest rates are lifted going forward.

“Much as we’d like Mr. Powell to pull back from the Fed’s recent hyper-aggressive tone, it’s probably too early,” says Ian Shepherdson, chief U.S. economist at Pantheon Macroeconomics.

“By September, though, the Fed’s first pre-condition for slowing or stopping the pace of rate hikes will have been met, because the headline month-to-month CPI and PCE prints for July and August will be much lower than in the past couple months,” Shepherdson also said on Friday.

The Fed’s suggestion in June that it could slow the pace of its interest rate rises once it reaches the neutral rate is most pertinent in light of the latest business surveys and due to the recent trend toward hiring freezes and layoffs at some of the largest U.S. companies.

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

June’s policy plan was motivated by a desire to cool the U.S. economy and labour market enough so that inflation begins to fall and eventually returns to the Fed’s 2% target, and there have been at least some indications of late that the Fed is having early success in this regard.

Should that success lead the Fed to favour sticking with the plan announced in June as opposed to encouraging a further ‘hawkish’ repricing of the outlook for U.S. interest rates on Wednesday, it would likely come as a headwind for the Dollar and be highly supportive of the Euro.

But the Euro to Dollar rate will also be sensitive on Friday to the release of Europe’s inflation figures for July and GDP data for the second quarter, which could impact expectations for European Central Bank (ECB) interest rates in September and beyond.

“A strong CPI on Friday will raise the prospect of another 50bp ECB hike in September (our call). But higher European interest rates are not enough to offset the negatives weighing on EUR in our view,” says Joseph Capurso, head of international economics at Commonwealth Bank of Australia.

The market-implied ECB interest rate for September 08 fell from 0.49% to 0.36% after last Friday’s S&P Global PMI surveys warned of a steep July downturn in the economy, suggesting investors now see a second 0.5% increase as a 50/50 prospect rather than a foregone conclusion.

Consensus among economists suggests that this Friday’s GDP data will show the Euro Area economy growing by 0.2% for last quarter, which would build on a 0.6% expansion from the prior period.

Meanwhile, Europe’s inflation rate is expected to edge higher from 8.6% to 8.7% and consensus suggests the pace of core inflation, which overlooks energy and food prices, is likely to climb from 3.7% to 3.9% for the month of July.