EUR/USD Forecast: A test of the 200-day SMA looms closer

• EUR/USD dropped further and approached 1.0800.
• The US Dollar gathered extra traction on firmer PMIs.
• The ECB might not reduce its interest rate in June.

The US Dollar (USD) extended its weekly recovery and kept EUR/USD under significant pressure on Thursday, pushing spot to new multi-session lows in the proximity of the 1.0800 neighbourhood.

The Dollar’s rebound aligned with robust data from preliminary US PMIs for the month of May and was also propped up by the strong performance in US yields across various durations, all amidst reignited speculation that the Federal Reserve (Fed) might keep its restrictive stance for longer than anticipated.

The above remained bolstered by the cautious tone from Fed policymakers, the solid health of the US economy, sticky inflation, and the still tight labour market.

According to the CME Group’s FedWatch Tool, there is nearly a 53% probability of lower interest rates by September (from over 60% on Wednesday).

Further support for the Fed’s current tight stance came from the FOMC Minutes of the May 1 meeting, which highlighted a debate about the restrictiveness of current monetary policy in light of the economy’s strength. This discussion is crucial, as the policy needs to be “sufficiently” restrictive to effectively curb inflation.

While the unchanged monetary policy landscape underscores the firm divergence between the Federal Reserve and other G10 central banks, particularly the European Central Bank (ECB), expectations of a rate cut by the latter diminished somewhat on Thursday after the ECB’s Negotiated Wage Growth increased by 4.69% in the January-March period, compared to 4.45% in the last quarter of 2023, reigniting caution ahead of a potential rate cut in June.

Looking ahead, the relatively subdued economic fundamentals in the Eurozone, coupled with the resilience of the US economy, support the ongoing narrative of Fed-ECB policy divergence and lean towards a stronger Dollar in the long run, especially considering the rising probability of the ECB reducing rates well before the Fed.

Given this perspective, the potential for further weakness in EUR/USD should be considered in the medium term.

EUR/USD daily chart

EUR/USD short-term technical outlook

On the downside, a break below the 200-day SMA of 1.0787 may prompt EUR/USD to revisit the May low of 1.0649 (May 1), followed by the 2024 bottom of 1.0601 (April 16) and the November 2023 low of 1.0516 (November 1). Once this zone is cleared, the pair may target the weekly low of 1.0495 (October 13, 2023), the 2023 low of 1.0448 (October 3), and the 1.0400 round milestone.

On the other hand, the pair is projected to find first resistance at the May high of 1.0894 (May 16), followed by the March top of 1.0981 (March 8) and the weekly peak of 1.0998 (January 11), all before reaching the critical 1.1000 level.

So far, the 4-hour chart shows a pick-up of the downward bias. That said, the 100-SMA awaits at 1.0797 prior to 1.0766 and the 200-SMA of 1.0748. The immediate up-barrier comes at 1.0861 ahead of 1.0884 and 1.0894. The relative strength index (RSI) decreased to about 38.