EUR/USD Analysis: Hawkish ECB commentary-led short-covering rally stalls ahead of 38.2% Fibo.

• A combination of factors prompted aggressive short-covering around EUR/USD on Tuesday.
• Hawkish remarks by ECB policymakers boosted the euro amid broad-based USD weakness.
• Aggressive Fed rate hike bets, growth concerns limited the USD losses and capped the pair.

The EUR/USD pair witnessed an aggressive short-covering rally on Tuesday and build on its recent bounce from the lowest level since January 2017, around mid-1.0300s touched last week. The strong intraday positive move pushed spot prices to a one-week high and was sponsored by a combination of factors. A general improvement in global risk sentiment - as depicted by the overnight rally in the equity markets - dragged the safe-haven US dollar away from a two-decade high. On the other hand, hawkish comments by the European Central Bank (ECB) policymakers lifted the shared currency and further contributed to the pair's bullish momentum.

ECB Governing Council member Klaas Knot said that a 25 bps rate hike in July seems realistic and a bigger increase must not be excluded either. Knot added that if data over the next few months suggest that inflation is broadening and accumulating, a logical next step would be a 50 bps rate hike. Separately, ECB Governing Council member Mario Centeno noted that the normalisation of the monetary policy is needed and must happen sustainably. Adding to this, an upward revision of the Eurozone GDP, showing that the economy expanded by 0.3% in Q1 as against 0.2% estimated initially, also acted as a tailwind for the common currency.

From the US, the headline Retail Sales recorded a robust growth of 0.9% in April and the previous month's reading was revised up to show a gain of 1.4%, double the 0.7% initially reported. Excluding food and energy costs, core retail sales grew more than expected by 0.6% during the reported month, though it did little to impress the USD bulls. The data, however, reaffirmed market expectations that the Fed would stick to its monetary policy tightening path over the next few months. This, along with the risk-on impulse, triggered a fresh leg up in the US Treasury bond yields and helped limit any further losses for the greenback, at least for the time being.

In fact, the markets seem convinced that the US central bank would need to take more drastic action to bring inflation under control. The bets were reinforced by Fed Chair Jerome Powell's remarks at a Wall Street Journal event, saying that he will back interest rate increases until prices start falling back toward a healthy level. Apart from this, concerns about the potential economic fallout from the Russia-Ukraine war and the latest COVID-19 outbreak in China kept a lid on the optimistic market move. This, in turn, drove some haven flows back towards the buck and prompted some selling around the EUR/USD pair during the Asian session on Wednesday.

Market participants now look forward to the final Eurozone CPI report ahead of the US housing market data - Building Permits and Housing Starts - later during the early North American session. The data might do little to provide any meaningful imputes, leaving the USD at the mercy of the US bond yields and the broader market risk sentiment. This, in turn, should allow traders to grab short-term opportunities.

Technical outlook

From a technical perspective, the overnight rally pushed the EUR/USD pair beyond the 200-period SMA on the 4-hour chart for the first time since April 21. The subsequent move up, however, stalled just ahead of the 38.2% Fibonacci retracement level of the 1.0936-1.0350 downfall. The said barrier, around the 1.0575-1.0580 zone, might now act as a pivotal point, which if cleared decisively should pave the way for additional gains. Spot prices might then reclaim the 1.0600 round figure and accelerate the momentum towards the 50% Fibo. level, around the 1.0650 region. Some follow-through buying will suggest that the EUR/USD pair has bottomed out in the near term and trigger a fresh bout of a short-covering move.

On the flip side, the 1.0500 psychological mark, nearing the 23.6% Fibo. level now seems to protect the immediate downside. Any further decline below the 1.0480-1.0475 region could attract some buying and remain limited near the 1.0425-1.0420 horizontal support. A convincing break through the latter would shift the bias back in favour of bearish traders and make the EUR/USD pair vulnerable to slide back below the 1.0400 mark. Bears might eventually aim to challenge the YTD low, around the 1.0350 region touched last week.