After hitting a high for the year, the EURUSD has been declining through most of the month. Normally, the explanation would be found in expectations around monetary policy. But, with the ECB expected to hold while the Fed is on a path towards easing, the currency move seems to defy expectations. But that doesn’t mean central banks aren’t having an effect on the pair.
Wednesday’s release of the minutes from the last FOMC meeting could be the highlight of the week’s economic calendar as traders try to figure out just when the next rate cut will be. The dollar lost over 10% of its value in the first half of the year, the fastest depreciation for the greenback since the 1970s. Ironically, a rate cut might help arrest that fall.
Backing Bags for Europe
Around 57% of the dollar index basket is the Euro, so it’s no surprise that the EURUSD has risen over 12% in the first half of the year. The EU has been the largest beneficiary of the tumult in US markets. Traders are shying away from the uncertainty around US trade policy and buying European assets in the hope that large spending increases in the EU will offer better returns.
Markets are concerned that the US economy will underperform, and high interest rates at the Fed contribute to that slow growth. The expectation is that the Fed will start easing at some point, but when is key for the dollar. A faster rate cut outlook would likely actually help the dollar in the current circumstances. That’s because easing is already priced in as inflation comes down. But the potential for a resurgence in the US economy could renew interest in US-denominated assets and bring back the dollar.
The Data Isn’t Helping
This dovish case is hard to make with the latest data, however. The latest jobs report showed 144K jobs were created in June instead of the 110K that were expected. Although that was below the 159K average of the prior month, beating forecasts gave the markets a boost. US equities hit all-time record highs on Friday.
What was more relevant to the markets, however, was an unexpected drop in the unemployment rate to 4.1%. This suggests that the labor market remains tight. On top of that, a week earlier, the Fed’s preferred inflation measure, core PCE price index, came in hotter than expected.
Hawks vs Doves
The argument for those in favor of rate cuts is based on an expected deterioration in the labor market, while those arguing for a hold point to the threat of inflation from tariffs. The recent data seems to align with the hawkish perspective. Which is why it’s not surprising that the chances of a rate cut in September went from 72% to 60%, and an expected third rate cut was priced out.
Markets are going to be looking at what emphasis FOMC members put on inflation and jobs in order to see how likely they are to vote for a rate cut under the current circumstances. If inflation remains the primary concern, then markets could remain disappointed and weaken the dollar. But more concern over the weakening labor market might increase the hope of easing in the near future, and ironically strengthen the dollar.
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