The recovery of the dollar casts uncertainty on market dynamics

• EUR/USD fell to three-week lows near 1.1040 on Tuesday.
• The US dollar gathered further pace amid geopolitical jitters.
• The EMU’s runaway inflation rate slowed further in September.

EUR/USD added to Monday’s decline and retreated to three-week lows near 1.1040 amid solid safe-haven demand and the continued strong rally in the US dollar (USD).

In fact, the greenback picked up a further pace as investors digested Chairman Powell’s shock tone in his speech on Monday, while Iran’s missile attack on Israel also bolstered demand for safer assets.

It’s worth remembering that Federal Reserve (Fed) Chairman Jerome Powell noted on Monday that the central bank is in no rush to cut interest rates. He also indicated that he expects two more cuts, totaling 50 basis points, this year, provided the economy performs as expected.

In addition, investors remained skeptical of recent announcements of further stimulus to the Chinese economy, another factor that appears to have poured cold water on the recent risk-on galaxy optimism.

On the monetary policy front, market expectations remained focused on further interest rate cuts by the Fed at its November and December meetings. Optimism about a soft landing for the US economy remains, although uncertainty remains about a repeat of the rate cut seen in September. The Fed’s updated dot chart suggests another 50 basis points of cuts this year, with Fed Chairman Jerome Powell assuring markets that the recent tapering was not a panic-driven response.

Also around the Fed, Atlanta Federal Reserve President Raphael Bostic explained that his basic expectation is a gradual easing of monetary policy over the next 15 months, ending with the Fed’s policy rate in the 3.00%- 3.25% until the end of 2025.

Meanwhile, the European Central Bank (ECB) eased its monetary stance at its September meeting, influenced by inflationary and economic conditions. Although the ECB did not suggest an interest rate cut for October, President Christine Lagarde noted that domestic inflation remains high. Lagarde stressed that easing the impact of restrictive policies could benefit the European economy, forecasting that inflation would return to 2% by 2025. Her stance on further action remains cautious, but there is growing confidence that the ECB’s inflation target will be reached.

In relation to the above, the euro bloc’s preliminary inflation rate saw headline CPI rise by 1.8% in the year to September, while core CPI is seen rising by 2.7% in the last twelve months.

Following the announcement, Finland’s ECB policymaker Olli Rehn argued that slowing inflation in the eurozone provides further justification for an interest rate cut at the ECB’s October meeting. He also noted that the recent weakening of the eurozone growth outlook supports this direction. Rehn indicated that the inflation rate in the euro zone is expected to stabilize at the bank’s 2% target by 2025. In addition, he stressed that Europe must find ways to increase productivity, as rising energy costs as following the invasion of Ukraine by Russia had a negative impact on industrial production. in the region.

Looking ahead, further Fed rate cuts could narrow the gap between the Fed and the ECB, potentially boosting EUR/USD. Market expectations currently point to two more rate cuts by the ECB and 100 to 125 basis points of easing by the Fed over the next 12 months. However, the anticipated outperformance of the US economy relative to the European economy could limit any significant or sustained dollar weakness.

Speculative euro positioning saw non-commercial net long positions hit a two-week high, while commercial players held net short positions almost unchanged with a slight increase in open interest. Despite the volatility, EUR/USD showed a modest uptrend, trading in the upper 1.1100 range during the observed period.

EUR/USD daily chart

EUR/USD short-term technical outlook

Fresh EUR/USD gains are forecast to meet initial resistance at the 2024 high of 1.1214 (September 25), followed by the 2023 high of 1.1275 (July 18).

The pair’s next downside target is the provisional 55-day SMA at 1.1022, which precedes the September low of 1.1001 (September 11) and the weekly low of 1.0881 (August 8).

Meanwhile, the uptrend of the pair is expected to continue as long as it continues above the critical 200-day SMA level of 1.0874.

The four-hour chart shows a resumption of the downtrend. The initial resistance level remains at 1.1214, followed by 1.1275. On the other hand, the initial level of dispute is 1.1045 followed by 1.1001. The Relative Resistance Index (RSI) has dropped to around 36.