Last week’s main theme has been a shift away from the US dollar towards currencies of economies with stronger fiscal positions and lower debt levels. The brief rally in long-dated US Treasuries helped fuel gains in gold and silver, while the Swiss franc also benefited from increased haven demand. The euro has performed reasonably well too, with the Eurozone economy continuing to expand modestly despite geopolitical uncertainty and higher energy prices.
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Last week’s main theme has been a shift away from the US dollar towards currencies of economies with stronger fiscal positions and lower debt levels. The brief rally in long-dated US Treasuries helped fuel gains in gold and silver, while the Swiss franc also benefited from increased haven demand. The euro has performed reasonably well too, with the Eurozone economy continuing to expand modestly despite geopolitical uncertainty and higher energy prices. For now, the EUR/USD outlook remains mildly bullish. Investors are looking forward to some US inflation data and the Jackson Hole symposium in the week ahead.
There has been a noticeable flight to quality in recent days, with investors favouring gold over equities and, in FX, seeking currencies backed by relatively stronger fiscal positions. The Norwegian krone, Canadian dollar, Swiss franc and euro have all held up reasonably well, while the US dollar and Japanese yen have struggled.
The bigger concern is the continued rise in bond yields across developed markets, particularly in the US. The US Treasury has responded with increased purchases of longer-dated Treasuries, initially triggering a sharp reaction across FX and crypto markets. However, yields have since returned to roughly their pre-announcement levels, suggesting the intervention has so far failed to produce a lasting decline in borrowing costs.
The intervention remains important for the dollar outlook. Although Treasury buybacks were originally intended to improve market liquidity, their timing and increased size suggest that policymakers are becoming increasingly uncomfortable with the rise in longer-dated yields. The decision to double long-dated buybacks to at least $4bn per operation, with scope for further increases, reinforces that impression.
For EUR/USD outlook, the key question is whether these developments further undermine confidence in US policy credibility. So far, the answer appears to be yes, albeit only modestly. If Treasury becomes increasingly willing to contain long-end yields, that could leave the dollar under pressure. A broader intervention programme could also weaken the dollar’s traditional safe-haven appeal, potentially benefiting both the euro and other major currencies.
Technically, the EUR/USD outlook has turned bullish following the break above the previous bearish trend and the subsequent upside follow-through. The pair has already reached the first major target around 1.1700, where the 50% Fibonacci retracement of the January-to-June downswing comes into play. Here, the pair has formed two doji candles in as many days. Usually a bearish sign this is. However, in the context of the larger breakout, this could be a bear trap. So, watch for a modest move lower, before the pair potentially breaks higher again, once the sellers are trapped.
On the downside, the 1.1575-1.1625 region is now the key support zone. The upper end of this range coincides with the 200-day average, while the lower end marks the origin of the recent breakout.
As long as EUR/USD holds above 1.1575, the technical bias remains bullish. A sustained break back below that level, however, would undermine the current bullish structure and suggest that the recent breakout may have been a false one.
Meanwhile, the next significant upside objective is around 1.1800, where the 61.8% Fibonacci retracement sits.
The next major test for the dollar comes on Wednesday, with the release of the US core PCE price index at 13:30 BST. If the recent CPI and PPI inflation readings are anything to go by, there is a reasonable chance that core PCE will also come in softer than expected. That would reinforce the argument that underlying US inflation pressures are easing.
However, this is the Federal Reserve’s preferred inflation gauge, so the market reaction could be significant in either direction. A surprisingly soft reading would probably reinforce expectations of a less restrictive Fed and could provide another leg higher for EUR/USD. Conversely, a hotter-than-expected figure could revive concerns about inflation and put renewed upward pressure on US yields and the dollar.
Then comes the Jackson Hole symposium on Friday, where Kevin Warsh will deliver his first major speech as Fed Chair. His comments will be closely watched, although he is unlikely to offer much in the way of explicit forward guidance given his well-known reluctance to do so.
Even so, Warsh could still influence markets by acknowledging the recent weakness in US economic data. Any suggestion that the Fed is becoming more comfortable with the inflation outlook could help alleviate some of the pressure from rising Treasury yields and, in turn, weigh on the dollar.
For EUR/USD, therefore, the near-term backdrop remains constructive. The technical trend is bullish, Eurozone data have been reasonably resilient, while questions over US fiscal policy, Treasury intervention and the direction of Fed policy continue to hang over the dollar. The key risk to this view is a renewed rise in crude oil prices in recent weeks.
— Written by Fawad Razaqzada, Market Analyst
Follow Fawad on Twitter @Trader_F_R
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