Euro-Dollar Has the Fuel to Hit 1.12, Says Soc Gen

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The Euro to Dollar exchange rate (EUR/USD) started the new week with fresh momentum as the market adjusts to the raised odds of a 50 basis point interest rate cut at the Federal Reserve on Wednesday.

This has lowered U.S. Treasury bond yields, which has tightened the gap between U.S. Treasuries and European government bonds, raising EUR/USD.

However, analysis from Société Générale says the gap has still not closed "and legislates in favour of further gains this week."

"A return to 1.12, the high post-Jackson Hole is in the balance if the Fed cuts 50bp on Wednesday," says Kit Juckes, head of FX analysis at Soc Gen.

That said, a smaller 25bp would underwhelm relative to market expectations, and Juckes thinks this could trigger profit-taking on Euro-Dollar.

From a technical perspective, the setup in EUR/USD is constructive. "EUR/USD broke out from a large symmetrical triangle and extended its up move," says Tanmay Purohit, a technical analyst at Société Générale, who notes 1.12 looks to be the key hurdle ahead.

Markets now see a 75% chance of a 50bp interest rate cut at the Fed on Wednesday, whereas this time, one week ago, the odds were at only ~30%.

The ramp-up in odds for a 50bp cut followed a pair of media reports last Thursday that said a 50bp was in play, with analysts noting the close links between the author of one article in the WSJ and the Fed.

Because the report is unsubstantiated, there is a real risk of disappointment. Should a 25bp rate cut be delivered, then the Dollar can recover and GBP/USD will drop sharply. "Sterling is vulnerable should the Fed only cut 25bp," says Clyde Wardle, Senior EM FX Strategist at HSBC.

Wardle says a 25bp cut scenario would see the USD shift onto better ground, "especially given the extensive pricing for rate cuts already factored into markets and signs of excessive short USD positioning."