EUR/USD drops below 1.2100 as ECB sources hint at potential rate cut

• EUR/USD dropped below 1.2100 in recent trade, down from the 1.2150 area during Asia Pacific trade.
• Dovish ECB commentary and USD strength amid a risk-off tone ahead of Wednesday’s FOMC meeting has weighed.

Dovish ECB commentary and a stronger US dollar amid a broadly risk-off market tone in the run-up to Wednesday’s FOMC meeting has weighed on EUR/USD; the pair recently dropped below the 1.2100 mark and is currently stabilising in the 1.2075 area, down about 0.7% or 80 pips on the day and well below Asia Pacific highs of around the 1.2150 mark.

Technical selling has also exacerbated the euro’s woes; the pair dropped below a short-term uptrend linking the 18, 20 and 26 January lows in the early part of the European trading session and the bears have been looking for a test of the monthly lows of just above 1.2050, a level which for now remains elusive.

Dovish ECB drives euro downside

The ECB has signaled what could turn out to be an important dovish shift in their monetary policy stance; early during the European session, ECB Governing Council Member Klaas Knot who is typically one of the more hawkish members at the bank made dovish remarks in which he said that the ECB has the necessary tools, including further rate cuts, to prevent any further strengthening of the EUR.

Meanwhile, not long ago, ECB sources cited by Bloomberg said that ECB officials reportedly think that markets are underestimating the odds that the bank might cut interest rates and policymakers at the bank are said to agree that such stimulus remains a viable option. The EUR has thus seen selling pressure on Wednesday’s as money markets reprice interest rate expectations towards the greater possibility of an ECB rate cut at the bank’s next meeting.

Other fundamental considerations

Risk-off flows into the US dollar are another key factor contributing to EUR/USD’s decline on Wednesday; despite all the dovish ECB stuff, EUR/USD is actually not even the worst-performing USD major on the day, with more risk-sensitive AUD/USD and NZD/USD both underperforming it.

In terms of why markets are risk-off, equity downside appears to be leading the dance. As to why stocks are lower, market commentators are citing a combination of Covid-19 lockdown, travel restriction and new variant concerns, fears of potential EU vaccine protectionism and profit-taking amid fears that, amid all the retail-driven speculative mania being seen in small-cap stock prices, the broader equity market might be in bubble territory.

Meanwhile, softer than expected February German GfK Consumer Sentiment and January French Consumer Confidence numbers are unlikely to be helping EUR’s cause. Bearish impulses are also likely emanating from signs that the French are mulling tougher lockdowns and tighter border controls and a downbeat economic forecast from the German DIW Economic Institute (they see the German economy shrinking 3% QoQ in Q1 2021). Mixed US Durable Goods data for December hardly had an impact on the price action.

EUR/USD hourly chart