Euro-Dollar Short-term Recovery Can Extend Above 1.1650
- Written by: Gary Howes
File image of Sébastien Lecornu. Source and credit: Ecole polytechniqueSource and credit: Ecole polytechnique.
We're seeing a brief window of opportunity for the euro to recover recently lost ground.
The euro to dollar exchange rate (EUR/USD) rises to 1.1630 after the Federal Reserve restrains the dollar and the French political premium recedes.
French Prime Minister Sébastien Lecornu told parliament he will suspend pension reforms to try and help his newly appointed government hobble on.
The concession means France can work towards delivering a new budget that will go some way in restricting the country's debt growth trajectory, and ease fears about the fiscal outlook.
Bond markets reflect relief, as the yield on French government bonds showed investors "welcomed these developments and the prospects of greater political stability," says a note from French bank Natixis.
The difference between the bond yields of France and Germany - a crucial indicator of how investors view France-specific risks - fell sharply as a result.
Fears for both France's finances and its government's stability weighed on the euro when Lecornu resigned last Monday. However, subsequent developments means some of that premium can dissipate.
Euro-dollar rises to 1.1630 at the time of writing midweek, having been as low as 1.1542 on Tuesday.
That 1.154 level now forms a new support line that could allow a recovery to evolve from.
Look higher, a rise towards 1.1650 is now the objective as euro-dollar looks to make contact with the descending 21-day exponential moving average:
For now, euro strength is likely to prove short-lived in line with the technical overview that shows a steady multi-week decline.
Given this, the tactical consideration for those buying dollars is to allow for some euro gains ahead of another dip.
With France likely to move into the background, euro-dollar is likely to take increasing direction from the dollar.
"The U.S. dollar is once again on the back foot after failing to retest the 1.1500 area in euro/dollar," says Achilleas Georgolopoulos, Senior Market Analyst at Trading Point.
"One of the key reasons for this dollar reaction was probably Tuesday’s Fedspeak and, in particular, the Fed Chair’s appearance," says Georgolopoulos. "The October Fed rate cut is almost certain."
Jerome Powell said in a speech to the NABE Annual Meeting, "this policy stance, which I see as still modestly restrictive, leaves us well positioned to respond to potential economic developments."
'Restrictive policy' is shorthand for interest rates that are high enough to restrict the economy to the extent it limits inflation. In this context, Powell is saying the Fed has ample room to cut interest rates without risking stimulating inflation.
Above: File image of Federal Reserve Chairman Jerome Powell. Image © Federal Reserve.
Powell said that weakness in the labour market is outweighing concerns about stubborn inflation.
Given his concerns that U.S. employment indicators are heading in the wrong direction, the inference is that the Fed can cut interest rates again to help employers while not risking pushing inflation higher.
A rally in stocks and a fall in the dollar confirm this interpretation was adopted by traders.
Powell kept the market pulse in check by warning there is "a risk that slow pass-through of tariffs could start to look like persistent inflation."
Nevertheless, having taken it all in, investors are clearly now far more confident an October 29 rate cut is on.
To be sure, other members of the Fed's Board of Governors remain worried about inflation, which implies the Fed is not ready to go all-in on a cutting cycle, which will limit USD weakness. A number of Powell's fellow governors should make this apparent over the coming days.
Another limiter to USD weakness is jockeying between the U.S. and China ahead of a potential new trade settlement.
This implies more threats from both sides and additional ad-hoc restrictions and sanctions on each other.
These headlines should keep enough caution in the mix to limit USD weakness, diminishing euro-dollar's upside potential.
