EUR/USD Supported after Wednesday’s Surge as Markets Digest Post-CPI Fed Commentary

Softer US Inflation

Yesterday's data showed that headline CPI Inflation eased to +8.5% in July year-over-year, from the 9.1% four-decades high of the prior month. On a month-over-month basis, there was zero inflation, down from +1.3% prior. Core CPI was more persistent, staying at 5.9% year-over-year.

The release came hot on the heels of Friday's blockbuster jobs report, which revealed that the Unemployment Rate dropped to 3.5% and pre-pandemic levels, giving credence to the strong economy and no recession narrative by the Federal Reserve.

US President Biden took note of those two data points yesterday, saying that they underscore "the kind of economy we've been building".

Fed Officials Stay the Course

The impressive jobs numbers give breathing room to the Fed for further aggressive tightening, but despite the defiant stance against prospects of a recession, Chair Powell had admitted last month that the path to a soft landing has "clearly narrowed".

Yesterday's cool down in inflation is probably a first sign that the central bank's actions begin to bear fruits, but they probably have little impact on the monetary path. One soft inflation print is not enough and policy makers will need to see more such numbers to back down from the front-loaded tightening. Furthermore, the upcoming meeting is still a month away and they will need to assess the newest inflation and jobs data that will come out by then.

Alluding to that, San Francisco Fed President (non-voter) said on Financial Times after the CPI release, that it is too early to "declare victory" on inflation fight ^[2]. Prominent hawk and non-voter, who will be voting next year though, Neil Kashkari struck a similar cord.

The Minneapolis Fed President noted that policy makers are "far, far away from declaring victory" on inflation and the CPI data do not change his aggressive recommendations for interest rates at 3.9% by the end of this year and 4.4% by the end of 2023%.[ fn ref="3"]

EUR/USD Analysis

The pair rallied after the softer inflation data, as markets repriced their expectations around the Fed's next rate move, on the dovish side. CME's Fed Watch Tool projects a smaller 50 basis points move as the most likely outcome, with nearly 60% probability, at the time of writing. ^[4]

EUR/USD could not end Wednesday above the critical 23.6% Fibonacci of the 2022 High/Low drop, but did manage to close above the EMA200 and remains supported today. This gives it the chance to try and take out the descending trendline from this year's high (at around 1.0390) and look towards the 38.2% Fibonacci (1.0540), but we are still a bit cautious.

Despite the cool-off in market expectations, Fed officials pushed back against declaring victory on inflation and the broader downtrend is still intact. Risk of pressure back towards (1.0122) has not yet gone away, but another test of parity looks like a distant possibility at this stage.