The EURUSD has come down from multi-months highs over the last few days, raising the question for swing traders if it’s time to buy the dip. What could be a catalyst for a rebound or push the pair lower is the last major data point out of the Eurozone before the ECB’s September meeting.
The market is projecting a 75% chance of a rate hike at the next decision, and that’s based primarily on continuing inflationary pressures. The ECB is expected to have a particularly aggressive hiking policy, with the market pricing in at least one more rate hike by December. This contrasts with the US, where the Fed is projected to maybe raise rates once.
Narrowing the Gap, Supporting the Euro
The divergence in policy outlook is actually likely to cause interest rates to converge. The Fed funds rate is almost double the ECB’s policy rate, so if the ECB hikes and the Fed does not, then the interest rate gap narrows. However, this makes the Euro more attractive, as it means there is less reason to sell Euros to buy dollars.
The run-up in the currency pair over the last month or so has been driven by shifting expectations around interest rates. US long-term yields rose to the highest levels since the sub-prime crisis, indicating that investors are growing concerned about US debt levels. Slowing economic growth constrains how much the Fed will be able to raise rates, but also how much funds the government has to pay its obligations. That means Congress might resort to even more deficit spending, contributing to higher inflation and undermining the real return on investment when holding dollars. At least compared to the Euros, where the ECB is clearly intent on getting consumer prices under control.
What Can Stop the Hike?
Markets are not unanimous in expecting a rate hike, which means there is room for the currency pair to move in either direction if the outlook shifts. The main reason that could happen is if there is a major beat or miss in the upcoming inflation data. ECB officials have been quite firm in suggesting they intend to deal with inflation, so signs of cooling consumer prices would take the wind out of the hawkish sails in Frankfurt.
However, the data release will be a bit uncomfortable for the market, as individual countries report ahead of the data for the whole of the Eurozone. This means that the market could already react when big countries like France and Germany report, if they are in line with the trend. Overall, traders are looking for inflation to match or beat expectations to confirm the upcoming ECB rate hike. That would likely firm up the EURUSD, particularly if around that time Fed Chair Kevin Warsh sounds a bit more dovish. On the other hand, a miss on the data could leave the markets delaying their expected rate hike, which could price out the subsequent tightening. The Euro would likely continue its downward trajectory.
What the Market is Looking For
The first data release is on Friday, when French headline inflation is published. The consensus if for Headline CPI to tick up to 2.2% from 2.1% a month earlier. German inflation comes out on Monday, and is projected to rise to 3.0% from 2.8%.
Assuming those figures are in line, then the market would likely only react to the later data if there is a substantial deviation from the trend. Eurozone Flash headline August CPI is projected to increase to 3.1% from 2.9% percent, with energy being the leading element raising prices. However, the core rate is also projected to rise to 2.6% from 2.5%, which is where the ECB focus will likely lie.
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