EUR/USD Upside in Focus as Inflation Data Looms

Data-Aligned View Surrounding Bullish EUR/USD

Progress on the Inflation front may add further USD weakness

Headline inflation in Q3 proved sticky but after more months of indirect tightening (via elevated bond yields and tighter credit conditions), a potential drop in inflation is likely see further USD selling.

Last week’s softer NFP labour statistics showed signs of the softening the Fed has been looking for to get inflation back to 2%. The futures market immediately reduced the likelihood of another hike and brought forward the start date of possible rate cuts in 2024.

A drop in inflation could build on this sentiment shift, weighing on the dollar which still trades at impressive levels. That is also not to say that the euro exhibits strength because recent GDP data would say otherwise.

The bullish view on EUR/USD is admittedly very data dependent – to borrow central bank jargon – and hinges on further signs (lower US CPI) that would suggest we have reached a peak in US rates. The chart below shows US PPI (blue) trending lower. PPI tends to lead CPI data by around 6 months, suggesting further drops in inflation are on the horizon.

USD Inflation Over Time

Source: Refinitiv, prepared by Richard Snow

One thing to note is that recent central bank speeches have revealed a greater defiance to the prospect of rate cuts by the ECB when compared to Fed members. While neither organization invites the idea of rate cuts, it is the ECB that appear more adamant in that regard.

Bullish EUR/USD Bias, Contingent on Further Data Backing Peak U.S. Rates

EUR/USD has advanced in an impressive fashion, reaching channel resistance with ease. Since then successive daily candles reveal extended lower wicks – suggesting a rejection of lower prices. However, this would need to be confirmed by a daily close on today’s candle.

What that does is highlight 1.0700 as a level of immediate support, keeping EUR/USD primed for another attempt at breaking out of the channel, with the 200-day simple moving average not far away. A return to channel support would invalidate the trade or at the very least delay the idea for a later date. 1.0831 is the level of resistance targeted on the upside.

EUR/USD Daily Chart

Source: TradingView, prepared by Richard Snow

Major Risk Events Ahead

In the absence of a drastically worse second estimate of EU GDP, the euro may find its footing after attempting to follow through on the recent lift in EUR/USD. Headline inflation in the US proved rather sticky but as the months go by, financial conditions will tighten even though there has been no change in the Fed funds rate since July. That is because US Treasury yields remain high (but have fallen from swing highs), credit markets have also added to tighter conditions after the senior loan officer survey concluded that tighter lending standards from banks and weaker demand for loans will affect overall activity.

If inflation misses estimates, markets may be more inclined to bet on rate cuts appearing sooner that later, potentially sending the dollar lower. Once again, this is contingent in the actually inflation data and the subsequent market reaction.

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— Written by Richard Snow for DailyFX.com

Contact and follow Richard on Twitter: @RichardSnowFX