EUR/USD Struggles to Defend Familiar Support as Crucial Data Loom

EUR/USD Analysis

EUR/USD is having a profitable year, helped by the monetary policy differential, as the European Central Bank has delivered 175 basis points of tightening in 2023, against the 100 bps of its US counterpart. The Euro's rate advantage has eroded though, since ECB President Lagarde opened the door to a September pause last month ^[1] and the Fed's higher-for-longer narrative is gaining traction.

The European economy sputters, with Germany in a technical recession and last week's PMI's underscoring the trouble. This creates apprehension and raises the bar for future hikes. The US economy on the other hand is very robust, the labor market tight and inflation still high, despite the substantial moderation. This sustains pressure for more tightening and Fed Chair Powell warned on Friday that policymakers are "prepared to raise rates further if appropriate" ^[2]. Markets responded to the hawkish messaging, as CME's Fed Watch Toll now assigns the highest probability to another 0.25% hike in November, for the terminal rate to be reached. ^[3]

The unwinding of the policy differential has been detrimental to EUR/USD, which runs a negative month and comes from a six-week losing streak – the worst since 2018. It tests the critical 200Days EMA (blue line), making it vulnerable to 1.0634-11, although it may be early to talk for further losses.

On the other hand, the ECB has more work to on inflation, which remains far for the 2% target and officials may have a hard time staying on the sidelines. On the Fed side, even though Chair Powell has kept the door open to more hikes, the terminal rate appears close.

EUR/USD tries to find some reprieve this week and a rebound towards the EMA200 (1.0930) would not be surprising, but that would require some catalyst. Daily closes above it, would pose the downside momentum, but the upside looks unfriendly, with a thick daily Ichimoku Cloud looming.

The pair is at a crucial technical junction, since the extent of its slide is so far in line with this year's previous correction (around 500 pips top to bottom). It tests the critical 200Days EMA, which has contained those pullbacks multiple times this year.

EUR/USD is in a tough spot and its trajectory will also be impacted by incoming data, which are crucial ahead of the September rate decision, since both central banks have touted their data dependence. PCE inflation (Thursday) and the employment report (Friday) stand out from the US and preliminary CPI inflation (Thursday) from Eurozone.