Euro-Dollar Unable to Hold Above 1.10, Slide in Euro-Zone Inflation Deters Further Buying

November 29, 2023 - Written by James Fuller

STORY LINK Euro-Dollar Unable to Hold Above 1.10, Slide in Euro-Zone Inflation Deters Further Buying

The US Dollar (USD) was subjected to sharp selling against the Euro (EUR) on Tuesday following a more dovish speech from Federal Reserve Governor Waller.

The Euro to Dollar (EUR/USD) exchange rate broke above the 1.1000 level with 3-month highs at 1.1018 before a retreat to 1.0975 on Wednesday amid weaker-than-expected Euro-Zone inflation data.

The US 2-year yield dipped to 4-month lows at 4.70% from 4.95% at the beginning of the week.

The German 2-year yield has, however, also declined sharply to 2.86% from 3.07% and this will limit the scope for further near-term Euro buying.

As far as US yields are concerned, MUFG asks the question; “Is this the start of a more sustained bull-steepening of the US yield curve? If so, it would signal plenty of more dollar selling to come. But what prompted this yield move yesterday?”

The bank highlighted a key section of Waller’s comments; “if you see this (lower) inflation continuing for several more months, I don’t know how long that might be – say 3mths, 4mths, 5mths – you could then start lowering the policy rate because inflation is lower”. He added that “if inflation goes down, you would lower the policy rate. There’s no reason to say you would keep it high if inflation’s back at target, for example”.

MUFG considers that lower inflation can only drive dollar selling so far. It notes; “While inflation could continue to fall (tomorrow’s PCE is likely to decline further) we will likely see further easing priced but it is hard to see this extend much further on inflation data alone. Hard activity data will need to weaken for rate cut pricing to extend much further from here.”

ING commented; “Looking ahead, the big question is whether this is the start of the big cyclical dollar decline we had envisaged developing through the first half of next year. This softer stance from Fed hawks warns that it is probably better not to fight the recent trend.”

It expects a consolidation phase in the short term with dollar selling on rallies.

Euro-Zone developments will also be watched closely and the near-term focus will be on inflation data.

Spanish consumer prices declined 0.4% on the month with the year-on-year rate sliding to 3.2% from 3.5% and compared with expectations of an increase to 3.7%.

The German inflation data will be released on Wednesday.

The data from several individual states has been released already and there have been consistent declines.

The Bavaraian inflation rate, for example, dipped sharply to 2.8% from 4.1% and below expectations of 3.7%. The Hesse rate slumped to 2.9% from 4.7% with the Saxony rate declining sharply to 3.9% from 5.4%.

The regional data indicates that the German national rate will be below consensus forecasts of 3.5% from 3.7% previously.

Alvin Tan, head of Asia FX strategy at RBC Capital Markets commented; “On an intraday basis (the euro) has come off the high so there has been some impact for sure."

He added; "But of course on the flip side U.S. bond yields are continuing to grind lower, there are two contrasting forces at play here."

The Euro-Zone inflation data will be released on Thursday with the headline rate forecast to decline to 2.7% from 2.9% with the core rate retreating to 3.9% from 4.2%

There are also important US releases on Thursday with the PCE inflation and jobless claims data.

According to ING; “Unless we see massive upside revisions to 3Q23 US GDP data today, we doubt EUR/USD needs to come a lot lower. And 1.0965-1.1065 could well be the holding pattern into tomorrow's US PCE inflation data.”

From a longer-term perspective, ING noted; “if and when the Fed gets ready to ease policy, market expectations will swing a lot more on USD rates than EUR interest rates.”

These expectations are behind ING’s forecast of EUR/USD gains in 2024 to a peak of 1.15.

HSBC maintains a cautious stance on the Euro; “The EUR appears to be struggling to make further upside gains, with yield spreads implying the pair belongs lower.”

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TAGS: Daily Currency Updates Euro Dollar Forecasts