• The United States Consumer Price Index was higher than anticipated in March.
  • The European Central Bank kept paving the way for a rate cut in June.
  • EUR/USD bearish momentum points to a downward extension towards 1.0500.

The US Dollar (USD) soared this week, sending EUR/USD to its lowest since November. Hotter-than-anticipated inflation in the United States (US) was the main reason behind the renewed strength of the USD, although it was not the only one.

Fed officials sit on their hands

Market players have been trying to determine when central banks will start loosening their monetary policies, something that has been on the table for over a year now. However, stubbornly high inflation has put a brake on policymakers’ will to return to normal. Meanwhile, higher interest rates affect economic development, albeit to different extents.

On Wednesday, the US Bureau of Labor Statistics (BLS) reported that the March Consumer Price Index (CPI) rose 0.4% MoM and 3.5% YoY, higher than anticipated. The core annual reading, which excludes volatile food and energy prices, was also above expected, resulting at 3.8%. The figures sent speculative interest in risk-aversion mode as they confirmed Federal Reserve (Fed) Chair Jerome Powell’s latest words. Powell said that the central bank is in no hurry to cut rates.

Financial markets went from pricing in three rate cuts for overall 2024 in December (the first one taking place in March), to thinking four months later that they would be lucky if the Fed trims rates twice in 2024, pushing the initial movement towards July.

The US also reported that the March Producer Price Index (PPI)  rose 0.2% MoM and 2.1% YoY, below expectations. The core annual PPI, however, was up 2.4%, above the 2.3% expected and the 2.1% posted in February.

European Central Bank officials need to cut rates

EUR/USD shed roughly 120 pips with the news, maintaining the negative bias on Thursday after the   European Central Bank (ECB) announced its monetary policy decision. The ECB left key rates unchanged, as expected. With this decision, the interest rate on the main refinancing operations, the interest rates on the marginal lending facility and the deposit facility were confirmed at 4.50%, 4.75% and 4.00%, respectively. The accompanying statement showed that policymakers believe it would be appropriate to reduce the current level of monetary policy restriction if inflation continues moving toward their goal. Furthermore, the Governing Council’s statement directly referred to a potential reduction of monetary policy restriction for the first time.  

ECB President Christine Lagarde, however, reiterated that the bank remains data-dependent and needs to build confidence in inflation converging to the target in a sustained manner. The central bank will have a full set of data in June, and speculative interest has increased bets on a 25 basis point (bps) rate cut by then.

So, on the one hand, we have the Fed dealing with a healthy economy and in no rush to cut rates, and on the other, the ECB is trying to be optimistic even though local economies are barely looking to be out of the woods. Lagarde did not say it, but European policymakers are actually in a rush to trim rates and revive economic growth.

When asked about the possibility of cutting rates before the Fed, Lagarde said, “We are not assuming that what happens in the Euro Area will be the mirror of what happens in the United States.” Still, Per Jansson, deputy governor at Sweden’s central bank, said that if the Fed rules out rate cuts in 2024, it could present a “problem” for the ECB.

Indeed, a rate cut implies a sharp depreciation of the linked currency. If the ECB acts first, it risks a sharp depreciation of the Euro.

The imbalance between central banks’ views and needs pushes EUR/USD towards 1.0600 at the end of the week.

The US Dollar maintained its positive momentum on Friday as Wall Street edged lower following reduced hopes for June rate cuts and tepid results from big banks. Among others, JPMorgan missed estimates on full-year net interest income, while Wells Fargo missed net interest income in its first-quarter report.

Markets align with central banks’ announcements

US Treasury yields deserve a separate note. In such a tumultuous week, American government bond yields soared to fresh 2024 highs, with the 2-year note offering around 5% mid-week. This level has been a critical catalyst for USD, as runs past it have fueled demand for the Greenback. Despite yields easing at the end of the week, they continue to reflect market concerns about persistently high rates.

The macroeconomic calendar will be much lighter next week, as the most relevant release will be US March Retail Sales. The International Monetary Fund (IMF) meeting and multiple Fed speakers will also stand out in the upcoming days.

EUR/USD technical outlook

The EUR/USD pair pressures weekly lows ahead of the close, in line with a continued decline in the upcoming days. From a technical point of view, long-term readings favor a downward extension. In the weekly chart, technical indicators head firmly south within negative levels as the pair aims to break below a flat 100 Simple Moving Average (SMA).  The 200 SMA lacks directional strength around 1.1140, while the 20 SMA gains downward traction between the longer ones, also reflecting increased selling interest.

The downward momentum is also clear in the daily chart. EUR/USD develops below all its moving averages, with the 20 SMA gaining bearish strength after crossing below the longer ones. Furthermore, technical indicators head south almost vertically within negative levels, in line with persistent selling pressure.

The EUR/USD pair has an initial support level at the 1.0600 mark, followed by the 1.0510-1.0520 price zone. A break below the latter could result in EUR/USD trading as low as 1.0440 in the upcoming days. To the upside, the former yearly low at 1.0694 provides resistance ahead of the 1.0770 price zone. Gains beyond the latter seem unlikely but will still fall short of flipping the tie, as EUR/USD needs to settle beyond 1.0940 to turn bullish.

Central banks FAQs

Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.

A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.

A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.

Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.

 

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