EUR/USD recovers after initially selling off on Middle East tensions
- EUR/USD has recovered after an early sell-off due to news of an escalation in the conflict in the Middle East.
- Israel purportedly launched drones at Iran in retaliation for its April 13 attack.
- EUR/USD is consolidating in a downtrend.
EUR/USD is trading in the mid 1.0600s at the time of writing, after recovering from an early bout of weakness. News reports of an escalation in the Middle East conflict had prompted a flight to the safe-haven US Dollar (USD), with a resulting decline in EUR/USD.
Overnight, reports of explosions in the Iranian city of Isfahan, which houses a military barracks, according to Reuters, suggested Israel has retaliated against Iran for its April 13 drone attack. The escalation had a direct impact on markets, with demand for safe-havens assets – Gold, CHF, JPY and USD – ratcheting up.
EUR/USD, which measures the number of US Dollars that can be bought with one Euro, fell back down to 1.0610 on the news, close to the 1.0601 April 16 year-to-date (YTD) low. Since then the exchange rate has recovered a bit, and is currently exchanging hands in the 1.0630s.
EUR/USD pressured by ECB comments
EUR/USD started Thursday bullishly after the President of the European Central Bank (ECB) Christine Lagarde stated “The game (of fighting inflation) is not over,” suggesting perhaps some doubt as to whether it was time to start cutting interest rates. Given the maintenance of higher interest rates is positive for a currency since it attracts greater inflows of foreign capital, the Euro (EUR) strengthened following her remarks.
EUR/USD reversed course after touching technical resistance just shy of 1.0700 and resumed its short-term downtrend as a roll-call of other ECB officials expressed the opposite view, i.e that cutting interest rates was necessary if not overdue.
The President of the Banque de France and ECB governing council member François Villeroy de Galhau, for example, stated that a cut to borrowing costs was due, and delaying could be detrimental to growth, placing the ECB “behind the curve”.
Vice-President of the ECB Luis de Guindos was more tempered, saying the central bank would reduce rates if the data evolved as expected. ECB governing council member Joachim Nagel said a June rate cut appeared increasingly likely, although certain inflation data remained higher than expected.
Fed members adopt increasingly hawkish line
EUR/USD’s reversal lower on Thursday gained momentum after the release of the Philadelphia Fed Manufacturing Survey’s Index Prices Paid component – a regional inflation metric – shot up unexpectedly to 23.00 (prior 3.7), suggesting price pressures remain alive and kicking.
Flat Initial Jobless Claims further reinforced the view that the US labor market is likely to continue to be a source of inflation.
Commentary from Federal Reserve rate-setters suggested a shift to an increasingly hawkish stance (meaning in favor of high interest rates for longer).
Atlanta Fed President Raphael Bostic said US inflation is returning to the Fed’s 2.0% target at a slower pace than many had anticipated, adding he’d be comfortable being patient, and that interest rate cuts are likely – but not until year end.
New York Fed President John Williams went further, saying he didn’t feel an urgency to cut interest rates and that monetary policy is in a good place.
Technical Analysis: EUR/USD consolidates within a bear trend
EUR/USD seems to be messing around in the gap between the YTD lows at 1.0601 and the resistance from the last major swing low in February at just shy of 1.0700.
The short and medium-term trends are bearish, suggesting more weakness will eventually come.
EUR/USD Daily Chart
The Relative Strength Index (RSI) has exited oversold conditions, indicating renewed potential for more downside.
A break below the 1.0601 April lows would post a lower low and give renewed confidence to bears. After that, the next concrete target is at 1.0446, the October 2023 low.
Resistance at around 1.0700 will need to be overcome for bulls to reappear. In the case of a really bullish move, the April 2 swing low at 1.0725 provides the next upside target followed by 1.0800, where a cluster of major Moving Averages coils.
US Dollar FAQs
The US Dollar (USD) is the official currency of the United States of America, and the ‘de facto’ currency of a significant number of other countries where it is found in circulation alongside local notes. It is the most heavily traded currency in the world, accounting for over 88% of all global foreign exchange turnover, or an average of $6.6 trillion in transactions per day, according to data from 2022. Following the second world war, the USD took over from the British Pound as the world’s reserve currency. For most of its history, the US Dollar was backed by Gold, until the Bretton Woods Agreement in 1971 when the Gold Standard went away.
The most important single factor impacting on the value of the US Dollar is monetary policy, which is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability (control inflation) and foster full employment. Its primary tool to achieve these two goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, the Fed will raise rates, which helps the USD value. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates, which weighs on the Greenback.
In extreme situations, the Federal Reserve can also print more Dollars and enact quantitative easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used when credit has dried up because banks will not lend to each other (out of the fear of counterparty default). It is a last resort when simply lowering interest rates is unlikely to achieve the necessary result. It was the Fed’s weapon of choice to combat the credit crunch that occurred during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy US government bonds predominantly from financial institutions. QE usually leads to a weaker US Dollar.
Quantitative tightening (QT) is the reverse process whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing in new purchases. It is usually positive for the US Dollar.