Where Is the Ceiling for EUR/USD Bull Rally?

  • Forex Analysis

EUR/USD is attempting to keep its head above the key near-term resistance after staging a near 8% rally off November lows. The U.S. dollar pushed back on Thursday after new U.S. retail sales data challenged recent claims that the pace of the Fed’s interest rate hikes can be slowed following the cooler-than-expected inflation report for October 2022.

Data for October showed that retail sales increased by 1.3%, ahead of consensus estimates of 1%. While this shows that the U.S. consumer is still healthy, despite a recent earnings report from Target (NYSE: TGT ) that would suggest otherwise, it also suggests that the Fed could opt not to slow down its aggressive hiking cycle.

“Markets have positioned for the Fed to pivot (but) the U.S. retail sales data very much challenges that narrative,” said Kim Mundy, a strategist at Commonwealth Bank of Australia.

“The U.S. economy is driven by the consumer, and if the consumer is still spending, it suggests it’s going to take inflation longer to ease.”

The data boded well for the U.S. dollar, driving the dollar index to 106.94, marking an increase of more than 0.6%. The DXY, which hit a 20-year high earlier this year, bounced back from a three-month low of 105.30 it hit on Tuesday.

Analysts Divided

Mary Daly, president of the San Francisco Fed and one of the most dovish central bank officials, also said a pause in interest rate hikes is not yet an option following the latest U.S. retail data. On a similar note, Kansas City Fed President Esther George said lawmakers must be cautious and not “stop too soon” with the rate hikes. She also said that avoiding a recession remains a challenging task for the U.S.

Current data from the Treasury market suggests that an economic slowdown can be expected as the gap between 10-year and 2-year U.S. government bonds widened to 67 basis points – similar to the one seen during the 2000 recession.

Prior to the retail data, the euro saw a sharp rebound from its 20-year low, driven by a substantial selloff in the greenback following the latest consumer price index print in the U.S. that showed that inflation eased to 7.7% in October, compared with consensus estimates of 8%.

The EUR has surged about 5% against the USD this month, hitting its highest level since July 2022. In the meantime, currency analysts are divided on where the dollar may be heading next.

ING economist Rob Carnell said it is likely that the U.S. dollar has already peaked, despite its latest jump.

Said Carnell:

"In order to think that there is much more dollar upside, you really have to anticipate there is going to be some tightening that we haven't expected ... and that somewhere in all of this there's a much bigger stock correction, which could send us back into a significantly risk-off mode that we'll want to just buy all things dollar again."

But despite the rally, analysts at UBS Global Wealth Management, Russell Investments and Insight Investment remain skeptical about whether the euro can maintain its sharp recovery.

The skepticism comes after the euro showed weakness on the reports of a missile hitting Poland, suggesting that the currency is highly exposed to the Russian-Ukraine war developments. Moreover, analysts believe that the possibility of the European Central Bank (ECB) slowing interest rate hikes could limit its gain potential as the bloc continues to grapple with record-high inflation.

The euro’s rally has likely ended for now, “unless we get another bout of stronger-than-expected data or more positive news flow on the energy situation,” said Dean Turner, an economist at UBS Global Wealth Management.

Turner expects the euro to have a difficult time ending the year above 1.04. He thinks that there is still no great level of confidence that the recent rally could strengthen further.

From the technical perspective, the 1.0350 is a key bull/bear line in the near term. If EUR/USD fails to keep its head above this level by the end of the month, it is likely that we will see a change in the direction, with the major currency pair likely to hit levels below the parity once again.

The bulls also seem to be struggling to break the resistance around 1.0420, where the 200-day moving average is located. A clean break of this zone would open the door for the continuation of this bear market rally, possibly towards 1.06.

Final Thoughts

The euro plummeted to a 20-year low against the U.S. dollar in September, after breaking its parity with the greenback in July due to concerns that Europe could see an energy shortage this winter. The single currency has recovered around 9% over the past two months, though most of its gains came from a sell-off in the dollar.

While trading activity on major forex brokers increases as investors are placing their bets on the Fed pivot, we’re also seeing a jump in equities. Any new data that points towards a still-hot U.S. economy will likely force Fed officials to reiterate their stance towards more rate hikes. In this case, the EUR/USD is very much heading below parity and possibly to the new multi-decade lows before the year end.

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