EUR/USD Forecast: Euro down but not out, the case for an upside correction

Big breakdown? The world's most popular currency pair has hit the lowest levels in the month, but bulls have been keeping up a fight. The dollar's upswing on Friday seems like a late reaction to robust higher than expected US inflation figures released on Thursday. Headline Consumer Price Index hit 5% YoY – a level last seen in 2008.

After the initial response was tame, the greenback did some catching up on Friday. However, demand for the dollar seems unjustified. First, it does not correspond to an increase in US bond yields, as returns on 10-year Treasuries remain depressed below 1.50%.

Secondly, the inflation monster is not as scary as it seems. Price increases were led by airfares, the cost of used cars and apparel, all items related to America's quick reopening and instant demand. It is also essential to remember that the 5% headline is also a result of base effects – inflation dropped sharply this time last year.

Third, Friday's dollar recovery came amid the release of the University of Michigan's preliminary Consumer Sentiment Index for June. The headline exceeded estimates with 86.4 points, but gauges of inflation retreated. Shoppers expect a 4% increase in prices within a year, below 4.7% expected. The annual pace of rises in the next five to ten years is 2.8%, also below estimates. 

The Federal Reserve is watching such forward-looking inflation gauges closely – and is unlikely to move without a clear signal that price rises are anchored into consumers' mindsets. The Fed is set to leave its policy unchanged on Wednesday, but some expect it to provide a subtle hint about tapering its bond-buying scheme later this year. With roughly 7.6 million people out of work and inflation that could be labeled transitory – aka reopening-related – the bank will likely stay put. 

US Inflation Analysis: As high as it gets? Fed may still stick to "transitory" stance, dollar could suffer

While traders need to wait until Wednesday for the Fed, talks about infrastructure continue elsewhere in Washington. After a bipartisan group of lawmakers laid down a compromise $1.2 trillion infrastructure deal, reports suggest that President Joe Biden may run into opposition from within his own party. Any delay in spending is dollar-negative, as it lowers inflation expectations. 

In the old continent, European Central Bank President Christine Lagarde has reiterated her stance that more accommodation is needed. Similar to the Fed, the ECB holds back on tapering its bond buys. While that is a negative for the euro, it seems priced in. Moreover, Europe's quickly catching up on the vaccination front balances ECB dovishness. 

All in all, there is room for recovery. 

EUR/USD Technical Analysis

The Relative Strength Index on the four-hour chart is near 30 – close to oversold conditions. That implies a potential bounce. Other indicators are more bearish – momentum is to the downside and the pair trades below the 50, 100 and 200 simple moving averages. 

Support awaits at the new low of 1.2090, followed by 1.2055 and 1.2015, levels that were last seen in May. 

Resistance is at 1.2115, the daily high, followed by 1.2145, 1.2160 and 1.22.