The U.S. dollar is on its way to close in the green territory on a weekly basis for the first time since the first half of July as traders increase their bets that the Fed may keep higher interest rates for longer.
EUR/USD was trading higher earlier this week, eventually hitting a two-week high on Wednesday following the release of data showing that U.S. private payrolls increased less than expected in August. Still, the greenback strengthened on Thursday despite some level of optimism that the U.S. central bank is near concluding its tightening cycle.
Overall, EUR/USD traded mostly range-bound despite heightened expectations for a November rate hike, triggered by relatively hawkish remarks made by Fed Chairman Jerome Powell during his much-anticipated Jackson Hole speech on Friday.
“We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.”
The market focus has now shifted toward the upcoming jobs report for August, which is anticipated to provide further confirmation that the labor market's tightness is diminishing amid relatively high interest rates. The NFP report is seen as an important factor that influences the Fed’s decision.
“The dollar’s falling on the belief that the Federal Reserve has done enough,” said Adam Button, chief currency analyst at ForexLive in Toronto. “I think nonfarm payrolls will be the final ‘stick the fork in it’ moment if it's soft.”
The market expects the U.S. added 170,000 jobs in August, according to economists polled by Reuters. Two days ago, the ADP National Employment report indicated that private payrolls increased by 177,000 jobs in the previous month, while analysts were looking for 195,000 net additions.
Amid speculation about the Fed and ECB's actions, some traders are turning to prop trading firms with fast funding to amplify their trading capacity, making the stakes even higher in volatile currency markets like EUR/USD.
What the ECB Will Do?
On the other hand, the European Central Bank (ECB) is now perceived as more likely to implement a September rate hike, while the Reserve Bank of Australia is expected to hold its rates steady amid slowing inflation.
The ECB decision could be more important for the EUR/USD than what the Fed will do after Eurozone inflation came in at 5.3% for the month of August, while economists were looking for a further decline to 5.1%.
Core inflation did ease as it was reported at 5.3% from July's 5.5%. This mixed inflation data is unlikely to provide a clear direction for the ongoing debate within the WCB regarding the need for further interest rate hikes.
"The upward pressure on underlying prices has thus continued to ease," Commerzbank economist Christoph Weil said. "We still do not expect the Governing Council to raise key rates further at its September meeting.
The central bank has faced a challenging economic environment with stagnant growth and weakening sentiment among businesses and households. Hence, the ECB stands undecided in a delicate moment for the Eurozone economy as officials deliberate whether further tightening is needed given the slowing economic growth.
According to Reuters, the probability that the ECB will deliver a rate hike in September has decreased from around 50% to 33%. Still, market pricing still indicates the expectation of another hike this year, possibly in October or December.
"I have not made up a decision because I don't have all the data, but I would not exclude that I would go for a hike. We are not yet at the highest level (for rates); it could be that we do another hike or two,” Robert Holzmann, Austria's central bank chief, told Reuters.
All in all, it looks like the debate around what the ECB will do is likely to extend into the week when the central bank meets (Sep 14). Those advocating for a pause in the tightening of monetary policy emphasize that economic growth is rapidly deteriorating.
With few catalysts to drive a rebound, there are concerns that the Eurozone's economy, which has remained stagnant over the past three quarters, could potentially slip into a recession. On the other hand, some policymakers point towards still-high inflation figures, which continue to be well above the ECB’s 2% target.
ECB board member Isabel Schnabel commented at the recent event:
"Real risk-free rates have declined across the maturity spectrum and are now back to the level observed at the February Governing Council meeting, as investors have revised their expectations for economic growth, inflation and monetary policy.”
“This decline could counteract our efforts to bring inflation back to target in a timely manner."
According to Bloomberg, ECB officials still see inflation outlook as “highly uncertain.”
“Emphasis was put on the merit of sticking to a data-dependent, meeting-by-meeting approach in an uncertain environment,” according to an account of their July policy meeting.
Final thoughts
The EUR/USD is on its way to closing lower in August after previously recording gains in June and July. The pair is still hovering around the $1.10 mark as investors continue to closely monitor the bond market developments, where U.S. yields rose to a fresh 16-year high in August.
Technically, the currency pair has consolidated above the broken 100 weekly moving average, which is a positive technical development. EUR/USD previously surged to test the 200-WMA resistance around $1.12 before correcting lower, which coincided with the correction in the U.S. stock market.
On a more negative note for the euro bulls, the current price action is taking place below the key bull/bear line that is located around $1.0950 and which connects the two important swing lows (January 2017 and March 2020). A definite break above this trend line would open the door for a more sustained rally in EUR/USD, especially if the U.S. bond yields also start to move lower from multi-year highs.
