EURUSD Test of 1.10 Could Open Door to Higher Levels

The Euro has strengthened against the dollar to 1.10 as investors expect greater interest rate cuts from the Fed than the ECB.

No Safe Haven Play

Last week, the most important economic event was not the Federal Reserve's rate decision as initially expected. A series of disappointing US economic reports, culminating in a sharp rise in unemployment, sparked major concerns about a substantial economic slowdown developing. Some worried that the Fed had waited too long to cut rates and would thus need to take more drastic actions later in the year, with most anticipating a 50 basis point reduction in September. Though widespread, the effects were most strongly felt outside the US.

The sudden narrowing of the expected interest rate difference between the US and Japan brought the yen carry trade to an abrupt stop, triggering a sell-off in Japanese stocks that then spread downturns across global markets. As Japan worked to restore stability to its financial systems (with the BOJ pledging no rate hikes), the dollar weakened as investors sought safer assets like gold. Yields on US Treasuries dropped in line with lowered rate forecasts but have since normalised, returning the yield curve to inversion.

The Key Difference that Matters

The ECB has already embarked on an interest rate-cutting path, with reference rates in the Eurozone now at 4%. Meanwhile, the Fed has yet to take action, and US rates remain at 5.25%. Growth in the European economy was not forecast to exceed 1% this year. In contrast, substantial US GDP expansion was anticipated after 'landing' concerns abated. Hence, should difficulties emerge, the US economy arguably has further to fall, leaving open the possibility of the euro becoming the stronger currency. This may be reflected in the recent rise in the EURUSD rate at the start of the week, as the market had already factored in initial ECB easing months prior.

Should a global recession emerge requiring central banks to slash rates to support economic activity, consensus holds rates will not turn negative again, given the limited effectiveness previously. This implies the ECB may ease by up to 400 basis points compared to 525 for the Fed. Yet slow growth is already accepted within Europe, with a technical recession not being uncommon. However, an economic slowdown would signify a notable shift for the buoyant US economy. Consequently, downside risk is greater for the dollar than the euro.​

EURUSD Needs to Retake 1.10

EURUSD has found resistance at 1.10 after breaking out of a triangular pattern, with higher prices increasing the probability of reaching the measured-move target level of 1.1689. Upcoming resistance is anticipated around 1.1140 and 1.1280 ahead of round price levels. Conversely, a break below 1.0775 could allow further declines to 1.065 and eventually 1.06. A move to this lower level may indicate the current upward trend has reversed, leading prices to 1.05.

Key Takeaways

The euro has strengthened against the dollar as investors expect greater interest rate cuts from the Fed than the ECB. With the US economy facing concerns of a substantial slowdown and higher rates than Europe, the market has factored in further easing by the Fed to support economic activity compared to the ECB, whose rates are already lower and growth forecasts more modest. This implies the interest rate differential between the US and the Eurozone may narrow further, weighing on the dollar relative to the euro.​