EUR/USD Needs Hawkish ECB, Less-Hawkish Fed to Sustain Strong Upside Momentum

The Euro regained parity against the U.S. Dollar for the first time in a month on Wednesday as weakening economic data solidified views that the Federal Reserve will slow the pace of its interest rate increases.

Helping to fuel the strong recovery in the Euro was a sharp decline in the U.S. Dollar, which weakened in reaction to a drop in the benchmark 10-year U.S. Treasury yield. The single-currency was also boosted by position-squaring and short-covering ahead of Thursday widely expected 75-basis-point rate hike.

At 20:00 GMT, the EUR/USD is trading 1.0081, up 0.0113 or +1.13%. The Invesco CurrencyShares Euro Trust ETF (FXE) settled at $93.01, up $1.06 or +1.15%.

Traders Scanning US Housing Data for Signs of Recession

Investors absorbed U.S. New Home Sales Data for September, which fell 10.9% from the prior month to a seasonally adjusted annualized rate of 603,000 units, according to the Commerce Department. It was better than the expected 13.4% decline to 593,000 units according to consensus estimates from the Dow Jones.

In August, the figure had hit a five-month high, coming in above market expectations. However, data published last week showed existing home sales had declined in September. Talks about a housing recession have been spreading as the sector is highly sensitive to interest rates.

This chatter is leading to growing speculation that the Federal Reserve will slow its rate hikes to half a point in December after making a fourth-straight 75 basis-point interest rate increase next Wednesday.

Traders Expect ECB to Stick with Aggressive Rate Hike Plan

The European Central Bank meets on Thursday and appears in no mood to alter its plans for aggressive interest rate hike given red-hot inflation – even as the economic outlook darkens.

Economists polled by Reuters anticipate a 75 bps rate increase to 1.5%, a view reflected in market pricing. Furthermore, recession risks are unlikely to stand in the way for now, but traders will be looking for signs on when a pause might come.

Short-Term Outlook

Breaking down the rally in the EUR/USD, we notice that a textbook move is taking place. While traders were pricing in a series of 75-basis point rate hikes by the Fed, the Dollar was soaring and the Euro was getting pounded. Traders were even saying that the ECB cannot keep up with the Fed so the attractive currency will remain the U.S. Dollar.

That was before the number of fresh signs of a decelerating economy in the United States. Last week’s and this week’s U.S. housing data combined with a contraction in overall PMI’s led to speculation that the Fed may pullback in December on its plans to aggressively raise rates until inflation starts to weaken.

With the Fed likely to match the ECB with a 75-basis-point rate hike on November 2, the focus will shift to December’s rate hike expectations.

If the Fed hints that it will slow the size of its future rate hikes to 50 basis points in December and the ECB indicates it will continue to raise rates by 75 basis points at its December then the EUR/USD rally is likely to continue.

If the Fed hints at a 50 basis point rate hike in December and the ECB suggests it will dampen the size of its rate hike at that time then we could see profit-taking hit the EUR/USD.

Essentially, with 75 basis points for the ECB and Fed essentially priced in, the comments about the size of the December rate hike will determine if the rally continues or tapers off.