The Euro spread its wings

Alexander Kuptsikevich FxPro

No matter how strong the trend, corrections are inevitable. The EURUSD pullback was driven by the closing of speculative longs after the Fed cut the federal funds rate, the fall in US stock indices, and strong macroeconomic data. However, as soon as investors bought up the S&P 500 dip and Fed officials started talking about continuing the monetary policy easing, the euro spread its wings.

Jerome Powell and his colleagues are ready to rescue the cooling labour market and ignore accelerating inflation. As a result, the futures market gives a 91% probability of a cut in the fed funds rate in October and an 81% chance of another cut to 3.75% in December. Moreover, the derivatives estimate a 27% probability of a rate cut to 3.5% by the end of the year.

ECB Chief Economist Philip Lane said that the chances of inflation in the eurozone returning to low pre-pandemic levels are slim. The probability of it rising significantly above the 2% target is negligible. Such rhetoric suggests that the European Central Bank has ended its cycle of monetary policy easing.

Thus, the rate differential between the ECB and the Fed will narrow, reducing the yield spread between US and German bonds. Historically, this has resulted in the euro rising against the dollar.

The rally in US stock indices is putting pressure on the USD. Foreign investors did not flee the US market after the White House introduced tariffs. They increased their stock holdings to $18 trillion, equivalent to 30% of the value of all US stocks. At the same time, non-residents are hedging currency risks by selling the dollar. As a result, a direct correlation between the euro and stock indices has become apparent.

As long as US stock indices continue to climb and the Fed lowers rates amid a cooling labour market, the chances of euro growth will increase. The main risks are a pleasant surprise from US employment in September and consolidation of the S&P 500 against the backdrop of seasonal volatility in October. A shutdown could be the reason for this.

Author

Alexander Kuptsikevich

FxPro

Alexander Kuptsikevich, a senior market analyst at FxPro, has been with the company since its foundation. From time to time, he gives commentaries on radio and television. He publishes in major economic and socio-political media.

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