EUR/USD: America's 'Wicked Problem,' ECB Eyed

• EUR/USD could attempt to extend rebound short-term
• After U.S. depositor bailout measures boost sentiment
• 'Wicked problem' of U.S. inflation poses a setback risk
• Lack of validation for market's ECB outlook also a risk

Image © European Commission Audiovisual Services

The Euro to Dollar exchange rate rallied sharply into the new week and could yet rise further up ahead but will also be at risk of setback if U.S. inflation becomes any more of a 'wicked problem' or should the latest interest rate guidance from the European Central Bank (ECB) leave the market dispirited.

Europe's single currency benefited significantly on Monday when Dollars were sold widely as a joint statement from the U.S. Treasury, Federal Reserve (Fed) and Federal Deposit Insurance Corporation (FDIC) drew a line under earlier global market concerns about the American banking system. 

The joint Sunday action bails out all bank depositors while simultaneously ensuring that owners and other creditors are bailed into the fullest extent possible following any institutional failures, eliminating a key risk that had been a significant burden on EUR/USD last week. 

"Unless there is a massive rally in US banking stocks today which suggested that US authorities had been incredibly successful in putting the genie of US banking sector risk back in the bottle, we would say EUR/USD is biased to the 1.0780/1.0800 area," says Chris Turner, global head of markets and regional head of research for UK & CEE at ING. 

"On Thursday this week, the European Central Bank policy meeting will be challenging. Presumably, it will have to push ahead with a 50bp hike for fear of adding even more volatility to the markets," he adds in Monday commentary. 

Above: Euro to Dollar rate shown at 2-hour intervals with selected moving averages. Click image for closer inspection. 

Sunday's supervisory actions are a short-term boon for the Euro but an equally significant influence this week will be in if U.S. inflation becomes any more of a 'wicked problem' on Tuesday because a fresh increase would likely lead to a EUR/USD-stifling rebound in expectations for U.S. interest rates. 

"We think the balance of risks looks likely to break in the Dollar’s favor over the next fortnight. On the one hand, Chair Powell very explicitly said the Fed is willing to speed up the pace in response to hotter data and upward revisions to Q4 2022," says Michael Cahill, a G10 FX strategist at Goldman Sachs. 

"This lends some credence to not only pricing a substantial probability of 50bp in March, but also helps justify the changing correlations to economic news over the last month. And, economic data this week continued to show an extremely tight labor market," Cahill and colleagues write in Friday market commentary.

The consensus among economists looks for U.S. inflation to fall from 6.4% to 6% for the month of February and for the more important core rate to decline from 5.6% to 5.5% but other price figures emerging from the U.S. in recent weeks have suggested that risk may be on the upside this Tuesday. 

"Tomorrow’s US CPI for February is the most important economic event in financial markets this week," says Carol Kong, an economist and currency strategist at Commonwealth Bank of Australia. 

Above: Financial model-derived estimates of probable trading ranges for selected currency pairs this week. Source Pound Sterling Live. (If you are looking to protect or boost your international payment budget you could consider securing today's rate for use in the future, or set an order for your ideal rate when it is achieved, more information can be found here.)

"A further lift in Eurozone core inflation means that ECB communication is likely to stay hawkish which can provide further support to EUR/USD," she adds.

Market-implied expectations for ECB interest rates have risen since early March when core inflation rose from an upwardly-revised 5.3% to 5.6% in a second consecutive defiance of Governing Council expectations for February, offering support to the Euro at the same time.

However, for the Euro the risk is more that for one reason or another Thursday's update offers little, if anything to validate elevated expectations. 

"We now expect the GC to offer no forward guidance on the pace of hikes for the May meeting. Even before the collapse of the Silicon Valley Bank, the GC was split on the type of communication to pursue," says Silvia Ardagne, chief Europe economist at Barclays. 

"Recent events will likely convince the GC not to make any commitment. We think that the main justification for the lack of forward guidance will be the numerous and very important data releases between the March and May meetings," Ardagne and colleagues write in a Monday research briefing. 

Above: Euro to Dollar rate shown at daily intervals with selected moving averages. Click image for closer inspection. To optimise the timing of international payments you could consider setting a free FX rate alert here.