{x} | Trading.live

Summary: The relative strength of the U.S. economy will put pressure on the EURUSD in the coming months, leading us to predict that the asset price will eventually return below the 1.0800 level.

Fundamentals

On Thursday, the European Central Bank (ECB) decided to raise three policy rates by 25 basis points. The deposit rate currently stands at 3.75%, in line with widespread market expectations. The ECB did not provide explicit guidance on potential rate hikes in September, as they will assess the strength of forthcoming data.

Balanced communication weighed the lagged effects of the implemented monetary policy measures against the strength of upcoming data. The ECB did not leave clear clues regarding potential rate hikes in September, as Christine Lagarde explicitly stated that no commitments would be made, but rather decisions would be data-dependent on a meeting-by-meeting basis. Therefore, the rate hike in September will depend on the data and staff forecasts available at that time.

While overall economic and inflation assessments align with expectations, we note that there have been subtle yet significant changes in guidance, enabling the ECB to proceed with the final rate hike on Thursday. The ECB changed the words "brought to" to "set" for their rate guidance to be "sufficiently restrictive levels" to bring inflation in line with the target.

That subtle change was clearly emphasized by Lagarde during the press conference, where she made clear that no decision or guidance is given for the September meeting, and even if they decide not to hike, this may not constitute the end of the hiking cycle, but may be a pause. She emphasized that a September decision will not say anything about the October decision. Lagarde said on a potential September hike that it is a "definite maybe".

The expectation of a rate hike in September faced challenges due to the lack of an economic rebound in August, with weak PMI and subdued bank loan surveys released earlier this week. However, the upcoming release of inflation data next week and clear conclusions for a September rate hike at the end of August will be crucial.

Overall, the ECB acknowledges that "inflation continues to decline but is still expected to remain too high for too long." Lagarde specifically highlighted the changing drivers of inflation, with external price drivers easing while domestic price drivers are becoming increasingly important. Significant increases in wages and profit margins are becoming potential sources of rising inflation. Overall, underlying inflation remains elevated. The ECB highlights that the recent deterioration in economic activity is primarily due to domestic demand, high inflation, and tightening financing conditions. The short-term economic outlook is expected to remain weak.

Technical Analysis

The EURUSD fell sharply below 1.1000 during the New York session on Thursday due to the market's dovish reading of the ECB meeting and a series of strong U.S. data releases (strong U.S. Q2 GDP figures and lower-than-expected U.S. initial jobless claims). In the closing days of July, the euro generally weakened against other G10 currencies, particularly against the U.S. dollar.

Regarding the U.S. dollar, as we have recently emphasized, we believe that the widespread weakness in the USD earlier this month was driven more by positioning and sentiment rather than fundamental factors. The overall theme for the U.S. economy in July has been signs of tightening inflation and increasing optimism about a soft landing, favoring cyclical currencies and driving the EURUSD to a new high for the year. Meanwhile, rising risk appetite and relative interest rate movements (especially weak U.S. Consumer Price Index in June) led to a USD sell-off in July, though momentum reversed somewhat over the past week.

We still maintain that the lagging effects of restrictive monetary policy have not fully impacted the Eurozone economy. In comparison to the relatively strong U.S. economy, the Eurozone economy remains fragile, showing signs of weakness, especially in the manufacturing sector. This is expected to be a headwind for the euro in the coming months.

It is also worth noting that, in nominal value terms, the euro's trade-weighted average is near historical highs. We find this difficult to explain solely from a fundamental perspective.

Overall, based on relative trade conditions, real interest rates, and relative unit labor costs analysis, we maintain our view that the EURUSD will continue to decline. The relative strength of the U.S. economy is expected to put pressure on the EURUSD in the coming months. We predict that the asset price will eventually return below the 1.0800 level. In terms of trading strategy, it is recommended to go short at highs.

Trading Recommendations

Trading Direction: Short

Entry Price: 1.1050

Target Price: 1.0760

Stop Loss: 1.1175

Valid Until: 2023-08-11 23:55:00

Support: 1.0945, 1.0894, 1.0830

Resistance: 1.1054, 1.1091, 1.1148