Euro to dollar analysis: EUR/USD in focus ahead of US CPI

• Euro to dollar analysis: Why is the EUR/USD trading higher?
• All eyes on US CPI – but could it overshoot and how would this influence Fed’s policy?
• EUR/USD Technical analysis points higher

Ahead of the publication of US CPI, the EUR/USD managed to climb above the 1.10 handle, up for the second consecutive day. However, it remained inside its existing ranges, suggesting traders were not opening any bold positions with the key risk events ahead. There was little news from the Eurozone to provide direction. But the fact it has turned positive on the week and reclaimed the 1.10 handle was clearly a positive development from a technical point of view anyway.

Why is the EUR/USD trading higher?

The EUR/USD stabilised on Wednesday, before making back its entire weekly losses in the first half of Thursday’s session.

Part of the reason why the EUR/USD is firmer is because of dollar longs taking profit ahead of the publication of CPI, which is why other USD pairs have also move in the similar direction, although the Japanese yen continued to weaken across the board, including against the dollar.

The mid-week recovery started as European stock markets were able to recoup Tuesday’s sharp losses, leading to a modest increase in risk appetite across the financial markets on Wednesday, before another late sell-off on Wall Street causes US indices to close in the red. So, the risk-sensitive EUR/USD pair was also able to climb for much of Wednesday’s session. There was some clarity on Italian government’s windfall tax on banks that had weighed heavily on the sector earlier in the week. The government confirmed that the levy won’t exceed 0.1% of each bank’s asset.

Meanwhile, the weaker Chinese CPI was also seen as a positive development for the EUR/USD as the PBOC now has more reason to unleash further stimulus i.e., a weak economy and threat of deflation. Anything to help China’s economy would boost Eurozone’s exports outlook, which would therefore be positive for the single currency. China being in deflation for the first time since January 2021, means it can export disinflation to the rest of the world still suffering from high levels of inflation, including the UK and Eurozone.

All eyes on US CPI

Whether the EUR/USD can hold onto its recovery will now depend on the direction of the US dollar, and that in turn will depend on the outcome of US data. Today, investors will turn their attention towards consumer inflation data, due for release later at 13:30 BST. US CPI inflation has fallen sharply in recent times, printing below-forecast readings in each of the past 4 months. Annual CPI fell to just 3.0% in June from around 6.5% at the start of the year, increasing the likelihood that interest rates have now peaked. But in so far as the July CPI is concerned, analysts expect a rebound in annual prices to 3.3%, mainly because of base effects. On a month-over-month basis, CPI is expected to climb 0.2%.

But could CPI come in higher?

Well, there is a risk that this could happen, given that services inflation remains high as strong wage growth continues to push up input costs. This is something that was highlighted in the nonfarm payrolls report on Friday, which showed average hourly earnings rising 0.4% month-on-month or 4.4% year-on-year – more than expected. Annual earnings have now increased by 4.4% in April, May, June and July. This shows that wage inflation is still going strong, and it is a concern for the Fed. This is especially the case for the services sector – which was also highlighted by the rise in prices paid index of the ISM services PMI.

How will CPI influence Fed’s policy?

So, as mentioned, there is a risk that CPI could overshoot expectations. But with the manufacturing sector clearly struggling, and now jobs market softening a little, the Fed will feel that its policy is restrictive enough to help cool price pressures further. So, a small beat wouldn’t matter too much, and I don’t think would provide lasting support for the dollar.

Until the Fed’s next meeting in September, we will have one more inflation report after this week’s one. Any further weakening of CPI could cement expectations of a policy hold. But the Fed will also monitor other macro indicators, including consumer confidence. On Friday, we will have the latest reading on the University of Michigan’s Consumer Sentiment and Inflation Expectations surveys to look forward to once CPI is out of the way.

But if most of these indicators point to continued strength in the US economy, then this should keep the dollar supported on the dips. That said, the bigger risk is tilted towards to the downside as most of the positive influences have already been mostly priced in, if not fully.

Euro to US dollar analysis: EUR/USD Technical analysis

Source: TradingView.com

The EUR/USD has now broken above its bearish trend line that had been in place since around mid-July, providing a positive technical indication about the trend. A close above the trend line is what the bulls will be eyeing today, because of the upcoming data release.

At the time of writing, the EUR/USD was approaching and trying to reclaim broken support around 1.1030-1.1050 area. If it manages to do that, this will be another positive technical development. The bulls must be pleased to see the EUR/USD holding onto key support around the 1.0900-1.0920 area it tested earlier this week. So, the EUR/USD may have bottomed out.

But the big risk is CPI and that could nullify any short-term bullish price structure we have seen this week. That being said, even if the EUR/USD dips slightly, this wouldn’t necessarily mean the end of the bullish trend.  For me, the line in the sand is at 1.0833, the low from July. Any move below that level would nullify this year’s bullish trend because we will then have a lower low in the EUR/USD.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R