Will EUR/USD Break 1.10?

Kathy Lien, Managing Director Of FX Strategy For BK Asset Management

Daily FX Market Roundup August

It has been a great week for the U.S. dollar, which recovered against all of the major currencies with the exception of sterling, which coasted on stronger UK data. The dollar’s rally was driven primarily by better-than-expected U.S. data. Retail sales doubled expectations while year-over-year CPI growth edged closer to the central bank’s 2% target. These reports validate Fed Chairman Jerome Powell’s recent comments about the economy’s resilience and his positive assessment of the labor market. What it doesn’t do is reduce the chance of easing. Fed fund futures are still pricing in 100% chance of a quarter-point rate cut next month so it will be very difficult for dollar bulls to remain in control. Thus far we haven’t heard many Federal Reserve officials say that a rate cut is coming. Typically, when the Fed’s guidance is misaligned with market expectations, they become more vocal and in this case, they could be holding off until Jackson Hole.

The Jackson Hole summit would be the perfect venue for the Federal Reserve to set or reset market expectations. A number of Fed officials will be speaking including Chairman Powell on Friday. When we last heard from the central bank, it made little mention of the need for further easing but given all of the developments since July, its language could/should change. If the Fed is committed to lowering interest rates in September, we should hear central bankers downplay the improvement in spending and retail sales. Some may even overtly press the case for easing, which would be very negative for USD/JPY and USD/CHF. However if the bank emphasizes the uptick in data, the dollar could soar on the notion that it might delay a rate cut.

The worst-performing currency was the euro, which sold off 4 out of the last 5 trading days against the U,S. dollar. Economic data has been mostly weaker with the economy contracting in the second quarter, investor sentiment (as measured by the German ZEW survey) hitting its lowest level since 2010 and industrial production falling by the steepest amount since November 2019. Eurozone PMIs are scheduled for release and there’s a very good chance that these numbers will come in softer, building the case for EUR/USD to break 1.10. However the euro found support at the end of last week from one important headline about the German government preparing to boost government spending if the economy falls into recession. The German economy grew in only one of the past 4 quarters, so recession is certainly in the realm of possibility. Fiscal stimulus would help a lot but it may be months before the German government announces any new spending measures. The ECB will ease before then and how the euro trades will depend on the extent of its stimulus.

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