Is the euro rally over?

The euro’s been letting off steam lately. A cool 800 pips off the lows and now testing the 200 day moving average. Is this just temporary relief or the start of a more meaningful move?

The chart tells a story. The 50 day moving average acted as resistance for the entire downtrend from the 1.15 zone. The trend shifted, price broke higher, and the 200DMA is the next hurdle for bulls to overcome.

From a fundamental perspective, some would argue that the war risk premium was being priced out of the single currency. The recent Ukrainian success in pushing back Russian forces was widely cheered.

Then a missile fell in Poland, and concern rose that NATO could enter the conflict due to an attack on one of their members. Investigations quickly concluded that this was an unfortunate accident - the missile was Ukrainian defence gone wrong. However, it served as a reminder of how precarious the situation remains.

Another argument is the rate differential between the EU & US. The spread between US 5 year bond yields and German 5 year bond yields has narrowed to 193bps (vs ~230bps when the euro was at its weakest).

An important question now is whether that spread will continue to narrow or begin to widen again, which is likely to depend on two main factors.

• The path of the economy
• The path of central bank decisions

The US economy remains strong. There are signs of slowing. Consumer debt is increasing, credit delinquencies are rising, and companies such as Amazon & Meta are cutting jobs. However, this hasn’t translated into job market weakness across the whole economy. Unemployment is still very low and wage growth remains high.

Fed Governor Waller commented yesterday that the soft CPI print and other data could mean that a slowdown in the pace of rate rises is on the cards:

"the data of the past few weeks have made me more comfortable considering stepping down to a 50-basis-point hike,"

But he’s not getting carried away yet…

"One report does not make a trend. It is way too early to conclude that inflation is headed sustainably down. Getting inflation to fall meaningfully and persistently toward our 2% target will require increases in the federal funds rate into next year. We still have a ways to go."

The European economy isn’t as strong as the US, and there is plenty to fret about in regards to the impacts of the surge in energy costs and effects on economic activity/production.

Bloomberg are running an ECB ‘sources’ piece, floating the idea that a step down to 50bps hikes could also be on the cards in the EU.

The perception is that if the Fed slows, it gives other central banks, such as the ECB, cover to match the size of their hikes. If inflation strengthens further on either side of the pond, those assumptions could be tested.

The inflation number on the 30th of November (ahead of the 15th December ECB meeting) is a key data point.

It’s a long road back to 2% inflation. The 200 day moving average could be a tough nut for EURUSD to crack until there’s more clarity on the path ahead.