Where now for EURUSD?

Since putting in a high of 1.2265 back in May 2021 the euro has steadily lost ground against the dollar, falling below the short-term support level of 1.1512 in the wake of flaming hot US CPI data on Wednesday.

Now in the 1.14s, the euro is down over 800 pips… Ouch!

So… Where next?

Right, let’s look at the drivers.

The dominant narrative: Inflation is running extra hot in the US & Wednesday’s 6.2% headline print certainly supports that theme.

Why does it matter?

One theory is that, the Federal Reserve will have to respond to this by closing their QE programme sooner than anticipated, then start rate hikes to tame inflation before it spirals out of control.

Among other factors this has seen the USD well supported.

Over In the EU, inflation is also running hotter than the ECB would like at 4.1%, but...

a) Not as hot as the US b) ECB projections see inflation falling back towards the 2% target in 2022 and even lower again (1.4%) in 2023.

ECB Chair Lagarde suggested that the Pandemic Emergency Purchase Programme (PEPP) is likely to end as scheduled in March 2022, but the fate of the smaller Asset Purchase Programme (APP) is yet to be decided.

This week, ECB Governing Council member Holzmann said that the ECB could stop buying bonds as early as next September (2022) if inflation looks to have sustainably returned to their official 2% target.

Now, Holzmann is a hawk among doves. The ECB is widely regarded as one of the most dovish G10 central banks.

The general commentary and messaging so far certainly supports the view that they will lag their peers when it comes to rate hikes.

So, it could be said that the EURUSD is tracking the differences in monetary policy....

But this central bank differential is widely-known…

And the longer a narrative or story circulates, the less impactful it often becomes.

See, narratives can become stale, and even though nothing has changed in reality, the ‘market mind’ moves on to the next theme.

What could change?

Well, the ECB have set their stall out pretty resolutely: President Lagarde recently said that a hike in 2022 is “off the chart” suggesting that they will not respond to any incoming data with a rate hike.

By contrast, Fed Vice Chair Clarida recently stated his belief that the “__three necessary conditions for raising the target range for the federal funds rate will have been met by year-end 2022__”.

His belief is based on projections. One of which is a 3.8% unemployment rate.

So far, the employment recovery has been fast and robust.

But if the pace of hiring were to slow in coming months and/or more workers rejoin the labour force but cannot find work it would not be surprising to see the euro regain some lost ground.

Especially if the Fed signals concern about this (and inflation begins to slow), market expectations for the time gap between monetary policies would likely narrow rather than widen further which could see more support for EURUSD.

Not investment advice. Past performance does not guarantee or predict future performance.