EUR/USD Rate: Rabobank see Further Weakness as Investors Finally Tune into Fed's "Hymn Sheet"

Image © European Central Bank

The pullback in the Euro has further to run with strategists at Rabobank saying currency markets have further adjustments to make on account of the Federal Reserve's message on interest rates.

The Dutch-based multi-national investment and merchant bank says Federal Reserve officials have been mostly consistent in their warnings that interest rates are set to be higher for longer.

"The Federal Reserve’s hymn sheet has not changed significantly for some time... the hawkish warnings from the Fed had appeared to fall on deaf ears," says Jane Foley, Senior FX Strategist at Rabobank in London.

A symptom of said "deaf ears" is the rapid rally in the Euro to Dollar exchange rate (EUR/USD) which peaked at 1.1033 on February 02 amidst expectations for an imminent end to Fed hikes and growing expectations for rate cuts as soon as the third quarter.

The cuts would be a response to a rapidly slowing economy, which many economists anticipate entering a recession this year.

"This outlook helped facilitate a strong start for US equities this year and a poor tone for the USD," says Foley.

At the same time, the European Central Bank was seen to be ready to out-hike the Fed with at least 125 basis points worth of hikes before midyear.

But markets were served a 'reality check' by a more sanguine guidance from the ECB on February 02 and a hotter-than-expected U.S. labour market report for January.

"Since the release of the far stronger than expected US January labour data at the start of this month, the markets have begun to listen to it (the Fed)," says Foley.

EUR/USD has since eased back and is consolidating near 1.07 over the past week, but further declines from here could be expected according to Rabobank's research.

U.S. retail sales data out midweek showed a sharp uptick in spending, suggesting the economy remains fit enough to continue churning out above-target inflationary rates.

The outturn raises "risks that the Fed will have to work harder to curtail demand and bring inflation under control," says Foley.

In response to the retail sales data, Rabobank says it retains a 3-month forecast of EUR/USD 1.06.