EURUSD halts rally as EZ inflation cools ahead of ECB

The EUR/USD surged higher yesterday as the dollar sold off, which gathered pace after the Fed’s Bullard said a rate cut might be warranted. The news also helped to push precious metals further higher. However, the euro’s rally has come to a halt, at least for now, following the publication of weaker-than-expected Eurozone consumer inflation data this morning. It remains to be seen which direction the world’s most heavily-traded pair is headed given the upcoming ECB rate decision and the US employment report later on this week.

Investors have been piling into the relative safety of German debt as stock markets sold off during May, driving yields lower. Yields have also fallen due to speculation that the ECB will deliver a dovish assessment of the economy and interest rates on Thursday, amid trade and Brexit concerns. But while bond yields have fallen sharply in Germany, they have dropped even sharper in the US as traders there started to aggressively price in (at least) one rate cut by the Fed this year. As a result, the German-US yield spread has been widening in the favour of German debt. In fact, the yield spread has been trending higher despite the fact the EUR/USD has been printing lower lows recently. If this trend continues, then the EUR/USD’s recent short squeeze bounce could well turn into a vicious rally.

However, the euro continues to run into trouble because of soft Eurozone data. And this morning, there was further bad news from the single currency bloc as consumer inflation came in sharply below expectations. Headline CPI inflation came in at 1.2% year-over-year for May, down noticeably from 1.7% previously and below expectations of 1.4%. Core CPI also disappointed at 0.8% vs. 1.0% expected and 1.3% last. Following the publication of the data, the EUR/USD eased back to turn flat on the day, but was still higher on the week.

It will be a busy week for EUR/USD traders given the sheer number of macro pointers scheduled for release from both economic regions. There is even a possibility for the EUR/USD to rebound again if the Fed’s Williams and Chairman Powell echo Bullard’s dovish views in their respective speeches later on today. Looking further ahead to the rest of the week, there will be lots to come from both sides of the Atlantic, which should provide plenty of volatility and therefore tradable opportunities in the EUR/USD exchange rate.

• The key event from the US will be the publication of the monthly jobs report on Friday. Ahead of that, we will see the release of ADP private sector payrolls report and ISM services PMI on Wednesday, followed by a few not-so-important macro pointers a day later on Thursday.
• From the Eurozone, we will have the final PMIs on Wednesday, followed a day later by a more important policy decision from the European Central Bank. Also, on Thursday we will have German factory orders and revised Eurozone GDP data, while German trade figures and industrial production, as well as a few other Eurozone numbers, will be published on Friday.

So, there are lots of macro events to follow of over the coming days. Ultimately, however, it will be the yield differential between Eurozone and US debt which is likely to have the biggest impact on the direction of the exchange rate. Eurozone yields will undoubtedly be impacted by the ECB’s policy decision on Thursday. Given ongoing trade concerns and easing by other central banks, with the RBA becoming the latest to trim its rates, the ECB isn’t going to talk up the prospects of a rate increase at this meeting. So, don’t be surprised if the EUR/USD gives back some further ground then. However if the ECB is surprisingly hawkish then in that case rates could break out. In any case, we will drop our short-term bearish view only in the event rates break above the most recent high and the 200-day moving average around 1.1325. Until and unless that happens, the path of least resistance would remain to the downside.

Source: TradingView and FOREX.com