EUR/USD Perches on Support Zone Ahead of Hot US CPI

Written on 10/02/2022 by Lukman Otunuga, Senior Research Analyst at FXTM

The Governing Council is getting increasingly concerned about elevated inflation, while at the same time seeing growth risks broadly balanced. Six days of gains in EUR/USD has seen the rally now stall ahead of the US inflation data released this afternoon.

On several occasions during the widely watched ECB meeting last week, President Lagarde had the opportunity to close the door on an interest rate hike in 2022, but she intentionally left it open. At the same time, Lagarde confirmed “sequencing” is important, indicating that the ECB would only raise rates after ending its net asset purchases.

Market gets excited, speakers confused

Inevitably after waiting so long for a more strident outlook to inflation, money markets went do-lally in relative terms towards ECB policy action going forward. Fifty basis points of hikes were swiftly priced which would roughly equate to five 10bp hikes through the year. But many see the current market pricing as too aggressive and are not wholly convinced by the bank’s recently found “hawkishness”.

Indeed, we have seen several ECB officials, including Lagarde, Villeroy and even known hawk Knot push back on rate hike expectations this week. The latter sees the first hike as soon as October, a far cry from the first increase expected by markets in June. President Lagarde noted that adjustments to policy will be “gradual” and that a rate hike will not occur before net asset purchase finish. Even a revised taper timeline would only be able to bring forward the first hike to early in the fourth quarter. This would result in potentially only two 10bp increases by the ECB at most.

On the flip side, the hawks have been crowing too, with Germany’s Nagel suggesting the ECB has now reached a point that is a “textbook case for central bank action”, with a hike by year end. Meanwhile Isabel Schnabel yesterday stressed the upside risks to inflation and the bank’s 2% target being hit in the medium term. More speakers are expected this week to add to the conflicting signals for policy direction.

EUR/USD unreactive into data

After plunging through long-term support at the November low at 1.1186 late last month, the single currency rebounded sharply, initially helped by bumper eurozone inflation figures. We now get the turn of the US data, with multi-decade highs expected. The key question is whether US inflation may be starting to roll over as supply chain disruptions and goods prices especially begin to ease. Money markets are currently pricing in more than five quarter-point rises by the Fed for 2022. Below-par data could set tongues wagging and we would then see how much that motivates the Fed to tighten this year.

The EUR/USD rally has paused for breath in recent sessions and is now trading around the 100-day simple moving average at 1.1416 and trendline resistance, turned support, around 1.14. Price action looks to be forming a bull flag pattern which could see an upside breakout toward a test of 1.16. Support is the 1.14 zone before the mid-1.13s.

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