Euro drops to monthly lows below 1.1550 amid high Oil pisces, Fed hiking bets

EUR/USD drops nearly 0.5% so far on Monday, hitting monthly lows below 1.1550.
High Oil prices and risk-off markets are crushing speculative demand for the Euro on Monday.
The US Dollar appreciated against most peers amid hopes of a Fed rate hike on Wednesday.

Guillermo Alcala FXStreet

The Euro (EUR) accelerates its downtrend against the US Dollar (USD) on Monday, weighed by risk-averse markets, with Oil prices above the $100 level and a stronger US Dollar, amid rising hopes of a Federal Reserve (Fed) rate hike on Wednesday. The EUR/USD pair is trading at fresh monthly lows below 1.1550 at the time of writing, after extending the reversal from 1.1650 highs last week.

The common currency struggles as Brent Oil trades near $104.00, following a more than 20% appreciation over the last two weeks. These prices pose a serious challenge to the Eurozone's economic growth and add pressure on the European Central Bank (ECB) to tighten its monetary policy further.

Fed hiking bets surged following August's CPI data

The US Dollar, on the other hand, is drawing some support from risk-aversion and higher hopes that the Fed will finally hike the Federal Funds Rate by 25 basis points to the 3.75%-4.00% range next Wednesday. US Consumer Price Index (CPI) figures released on Friday showed that core inflation rose in August at its fastest pace in the last two months, forcing the central bank to tighten its monetary policy or risk a credibility crisis.

Analysts at MUFG/BTMU warn that if the Fed "does not take action this week to address upside inflation risks, it could trigger a sharp sell-off for the US Dollar and long-term US Treasuries by undermining confidence in their willingness to get on top of inflation." They argue that this uncertainty "could be one reason why US Dollar gains have only been limited so far on the back of the hawkish repricing of Fed rate hike expectations.

Looking ahead, the MUFG/BTMU experts observe that "US Dollar strength in the near-term could also be curtailed by the close proximity of the US mid-term elections." Even if the Fed begins to hike rates at the upcoming meeting, they suggest policymakers "may be reluctant to deliver a back-to-back hike at the next meeting on 28th October, which comes just before the mid-term elections on 3rd November," implying that "the next hike may then not be delivered until 9th December."

In the Eurozone, the European Central Bank (ECB) hiked rates last week and hinted at further tightening over the coming months, a hawkish stance that was further endorsed by President Christine Lagarde over the weekend. Lagarde said that the Energy shock will be long-lasting and reaffirmed the bank's commitment to maintaining price stability.

Interest rates FAQs

What are interest rates?

Interest rates are charged by financial institutions on loans to borrowers and are paid as interest to savers and depositors. They are influenced by base lending rates, which are set by central banks in response to changes in the economy. Central banks normally have a mandate to ensure price stability, which in most cases means targeting a core inflation rate of around 2%. If inflation falls below target the central bank may cut base lending rates, with a view to stimulating lending and boosting the economy. If inflation rises substantially above 2% it normally results in the central bank raising base lending rates in an attempt to lower inflation.

How do interest rates impact currencies?

Higher interest rates generally help strengthen a country’s currency as they make it a more attractive place for global investors to park their money.

How do interest rates influence the price of Gold?

Higher interest rates overall weigh on the price of Gold because they increase the opportunity cost of holding Gold instead of investing in an interest-bearing asset or placing cash in the bank. If interest rates are high that usually pushes up the price of the US Dollar (USD), and since Gold is priced in Dollars, this has the effect of lowering the price of Gold.

What is the Fed Funds rate?

The Fed funds rate is the overnight rate at which US banks lend to each other. It is the oft-quoted headline rate set by the Federal Reserve at its FOMC meetings. It is set as a range, for example 4.75%-5.00%, though the upper limit (in that case 5.00%) is the quoted figure. Market expectations for future Fed funds rate are tracked by the CME FedWatch tool, which shapes how many financial markets behave in anticipation of future Federal Reserve monetary policy decisions.

Author

Guillermo Alcala

FXStreet

Graduated in Communication Sciences at the Universidad del Pais Vasco and Universiteit van Amsterdam, Guillermo has been working as financial news editor and copywriter in diverse Forex-related firms, like FXStreet and Kantox.

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