EUR/USD: Can U.S. Inflation Data Deepen the Fed-ECB Divide?

EUR/USD declined to 1.1312, a 15-month low yesterday, amid diverging Fed-ECB policy outlooks and as investors look ahead to eurozone and U.S. inflation data. The price has risen to 1.1340, but the outlook remains vulnerable.

The U.S. dollar has risen to an almost two-month high, supported by expectations of further Federal Reserve rate hikes.

Elevated oil prices, with Brent over $100, combined with strong economic growth (US PMI data reached a 5-year high last week), have fuelled inflation concerns.

U.S. Treasury yields are at multi-decade highs, with the 10-year trading above 5% and reaching 5.27% this week. The 30-year yield is also at its highest level since 2002, supporting demand for the dollar.

Markets are pricing in a more than 70% probability that the Fed will hike rates again in October, up from around 50% at the start of last week. The Fed raised rates by 25 basis points last week, while Fed officials have continued to lean hawkish in recent speeches.

What to expect from Core PCE data?

Attention now turns to today’s core PCE data, the Fed’s preferred gauge of inflation. Core PCE is expected to hold at around 3.3% to 3.4% year-on-year in August, while the monthly reading is expected to rise to 0.3%, from 0.2%.

U.S. non-farm payrolls will be released on Friday and are expected to show 100,000 jobs added in September following impressive job creation of 162,000 in August.

A combination of sticky inflation and strong job growth could cement expectations of an October rate hike, lifting USD further.

Diverging ECB-Fed policy

Meanwhile, the euro has fallen 2.2% in September despite the ECB hiking interest rates by 25 basis points earlier this month.

In addition to surging global energy prices, fragile growth and heightened political risks in Europe are also weighing on the currency. German retail sales were weaker than expected at -0.4% MoM in August.

In a speech earlier in the week, ECB President Christine Lagarde said that a cautious and gradual approach is appropriate for containing inflation, pushing back against expectations of more aggressive rate hikes and a hike at the October meeting.

This divergence in monetary policy between the Fed and ECB is reinforcing the weaker euro, stronger dollar dynamic.

U.S. economic data this week is therefore increasingly becoming a critical inflection point for assessing whether the dollar’s strength can be sustained.

EUR/USD technical analysis

EUR/USD trades with a bearish bias below its 200 and 50 EMAs and a multi-month falling trend line. The pair dropped to a 15-month low of 1.1312 before recovering slightly to 1.1330 at the time of writing.

The RSI is the most oversold it has been since March on the daily chart, suggesting that a period of consolidation or a move higher could be on the cards.

Sellers would need to close below the 1.1340 support zone to bring 1.1300 into focus, with a break below here opening the door to 1.1210, the 2025 low.

Any recovery would need to rise above 1.1450, the April low, and 1.1500, the 50 EMA and horizontal resistance. A move above the 200 EMA at 1.1500 and horizontal resistance at 1.1580 would put the recovery on a firmer footing, while a rise above 1.1600 would create a higher high and bring the falling trend-line resistance into focus.