EUR/USD Rebounds to Critical Tech Levels as the Fed Turns Dovish Due to Higher Yields

EUR/USD Analysis

The attack of Hamas on Israel and the country's retaliation sent energy commodities higher and created risk-aversion. The USDOLLAR has been unable to benefit from safe-haven flows, as it was weighed by a dovish shift in Fed commentary, as various voters appeared worried about the surge in bond yields over the past several months, with the 10-year having hit the highest levels since 2007.

Mr Kashkari on Tuesday found this rise "perplexing" and hinted that the elevated levels could prevent the Fed from further hikes, saying "it's certainly possible that higher long-term yields may do some of the work for us in terms of bringing inflation back down" ^[1]. These comments echoed the remarks of Ms Logan a day earlier, who noted that there "may be less need to raise the fed funds rate" if long-term rates remain elevated. ^[2]

However, the flight to safety from the Middle East conflict is putting downward pressure on yields this week. Furthermore, inflation is still high (and these events can sustain it), the labor market hot and the economy strong, keeping pressure for further monetary tightening. The IMF upgraded its GDP projections for the US on Tuesday, to 2.1% for this year and to 1.5% for 2024 ^[3]. Officials had adopted a hawkish stance last month, as they maintained their 5.6% medial terminal rate projection, which implies one more hike this year.

This change in the Fed narrative has allowed EUR/USD to rebound from the 2023 low at the start of the month, now trying to surpass critical tech levels in the 1.0635-65 region, which includes the 23.6% Fibonacci of the last leg down. Successful effort can accelerate the recovery to the 38.2% Fibonacci at 1.0763.

However, the upside looks unfriendly and we remain cautious around the ascending prospects under the current monetary policy dynamics. The European central bank had hinted to peak rates after September's hike and commentary since then has largely been in line with that, as the European economy struggles, especially Germany. The country's GDP flat-lined in Q2, after two straight quarters of contraction and the IMF sees it at -0.5% this year.

Below the 200Days EMA (black line) immediate bias remains on the downside and EUR/USD is still in risk of new 2023 lows (1.0448), although deeper losses below 1.0337 have a higher degree of difficulty. The Death Cross on the daily chart (EMA50 < EMA200) does not allow for much optimism. This formation is often a precursor of sustained weakness. It last occurrence was around two years ago, eventually leading the 2022 multi-year lows.

Markets now turn to the Fed minutes of the September hold later today and the CPI inflation update on Thursday, which can determine the next leg of the move.