Euro-Dollar Week Ahead Forecast: Too Soon to Fade

Image © European Central Bank

The Euro to Dollar exchange rate is in an undeniable uptrend, and although it looks overbought, it will take a brave punter to bet against further gains this week. Beware any month-end volatility.

The Euro's rally against the Dollar leaves it overbought as per the Relative Strength Index (RSI), which is now at 70. To be sure, the exchange rate was even more overbought last week and the relatively steady trade seen in Euro-Dollar over Monday and into Tuesday has allowed some of those overbought conditions to unwind.

This serves as a reminder that the RSI can unwind from overbought on a static exchange rate and that it does not necessarily signal a pullback.

The overarching theme we look for into month-end is a more subdued price action in Euro-Dollar with the recent highs potentially proving elusive for the time being.

Analyst Shaun Osborne at Scotiabank sees another technical signal that hints at near-term exhaustion, although his thesis is that near-term weakness will prove limited:

"Short-term trading patterns suggest the EUR may have peaked in overnight trade after forming a bearish 'evening star' pattern on the 6-hour charts. Minor losses through quiet European trade tend to confirm that development. But losses are likely to remain limited in the short run at least."

The Euro rose sharply against the Dollar on Friday after Federal Reserve Chair Jerome Powell effectively greenlighted a September interest rate cut: "The time has come for policy to adjust," said Powell in a speech to the Jackson Hole symposium.

The speech was surprising in that it made repeated references to fears that the labour market is at risk of deteriorating, which signals the Fed that it needs to cut rates to protect jobs. Markets hiked expectations that the Fed could kick off its rate cutting cycle with an outsized 50bp cut.

"Hard to love the euro from a local fundamental perspective still; soggy data and if inflation is reasonably well behaved this week, a likely further ECB cut in September to come. However, with broad dollar weakness, we broke above the December '23 highs, and the next target remains the Summer 23 highs of 1.1275," says a note from the FX dealing desk at JP Morgan.

Thursday sees German and Spanish inflation releases and any surprises here can shake the market ahead of Friday's all-Eurozone inflation release.

The consensus expectation is for HICP to print at 2.3% year-on-year, and any undershoot can weigh on the single-currency.

Dollar trade in the coming week will be determined by how expectations for a 50bp cut evolve: if they increase, Euro-Dollar can rise. If they fade, the exchange rate can pull back again.

The data highlight will be Friday's release of the PCE deflator, which is a measure of inflation impacting consumers. The Fed tends to watch it closely, but we think there is a limited chance of it throwing up the kind of surprise that would shift the broader narrative.

Powell said in his Jackson Hole speech he was confident inflation would not make a surprising return and that he was now much more focused on the labour market. This suggests that the early-September release of the U.S. non-farm payroll report will be the next major event for the Dollar.

The next major U.S. data release will be next Friday's U.S. job report. But, also be aware that we are approaching month end. This can throw up some unusual newsless currency market action, and we would not see any unusual moves as a signal that current trends are changing.