Weekly analysis

The sharp fall toward the end of last week could be a sign that the Euro’s four-month-long rally is losing steam.

EUR/USD dropped after US jobs and services data beat expectations, leading to a repricing higher in US rate expectations. Rate futures now indicate the Fed to hike at least two more rate hikes, taking the benchmark to above 5%. Before Friday’s data, the market was expecting the benchmark rate to peak below 5%.
This follows a 25 basis points hike by the US Federal Reserve and a 50 basis points hike by the European Central Bank (ECB) last week. While the Fed acknowledged early signs of disinflation, Chair Powell said the central bank could conduct a few more rate hikes to bring down inflation to its target. The ECB, on the other hand, maintained its hawkish stance. On balance, while ECB wasn’t incrementally hawkish, the Fed wasn’t as dovish as some had expected, weighing on EUR/USD.

On technical charts, EUR/USD had been struggling to extend gains in recent weeks ahead of stiff resistance around 1.0900, including the 89-week moving average and a slightly upward-sloping trendline from 2017,as pointed out a couple of weeks ago. Moreover, a negative momentum divergence on the daily and weekly charts  raised the odds of a pause/minor setback in the near term, as highlighted last week.
EUR/USD posted a bearish shooting star pattern on the weekly candlestick charts and is now approaching important support at about 1.0700-1.0750 . EUR/USD hasn’t been able to decisively break below the 200-period moving average suggesting that 1.0700-1.0750 could be tough to break, at least in the first attempt.

However, any break below the support would confirm that the upward pressure had faded, pointing to the possibility of an extended range in the short term. Subsequent support is at the January low of 1.0480. Strong support is on the 200-day moving average (now at about 1.0320). The uptrend since late 2022 is unlikely to reverse while EUR/USD holds above the long-term moving average. 

The ECB administered a hawkish broadside , raising its forecasts for headline inflation to 6.3% for next year and 3.4% for 2024 (From 5.5% and 2.4% previously, suggesting a far longer time frame with uncomfortably high inflation. The core CPI forecasts were raised to 4.2% ex food and energy for 2023 and 2.8% for 2024, versus 3.4%/2.3% in September). It also outlined its quantitative tightening plan to start rolling off EUR 15 billion of asset per month from March, with ECB President Lagarde claiming the willingness to continue to hike 50 basis points at several coming meetings if necessary, with a general message that there is far more rate tightening to do from here. But after an initial sprint higher that saw EURUSD trading well above 1.0700 despite relative USD firmness elsewhere, the EURUSD collapsed back toward 1.0600 before stabilizing closer to 1.0650 this morning and then easing lower again. Still, the euro was very firm against most of the rest of G10 currencies as the German 2-year yield jumped a full 25 basis points on the day and closed the day at a cycle high (and high since 2008) of 2.39%. EURJPY leaped two figures higher.

On February 2, the BoE is set to increase its benchmark interest rate by a half-point to 4%, but analysts will watch for signs that this will be the last time the BoE raises rates.
Cable could prove one of the more vulnerable USD pairs next week to USD strength if we see a combination of market complacency yielding to a bit more uncertainty (bad US data could prove bad news for risky assets on the impact on corporate earnings, and supportive of the USD, while stronger than expected US data could support the USD on repricing the forward Fed expectations back higher). Only a very gentle soft-landing scenario would seem able to keep the USD bears in business here. As well, we could see the Bank of England allowing itself to indulge in less hawkish guidance (to reduce their role in adding to the severity of the oncoming recession) after the recent sterling strength and decelerating inflation data.

Investors also expect the Fed to raise interest rates by 25bps next week. Apart from that, they will pay close attention to the nonfarm payrolls showing the state of the US labor market.
The daily chart shows GBP/USD trading near the 1.2401 resistance level. It also trades above the 22-SMA, indicating buyers are in charge. The RSI trades above 50, favoring bullish momentum. On the larger scale, the price is chopping through the 22-SMA, a sign that the price is caught in a sideways move. It is trading between the 1.1905 support and the 1.2401 resistance levels.

The GBP/USD weekly forecast is flat as investors will likely sit on their hands until inflation data comes out ahead of the central bank meetings.

This past week, investors were interested in US data, such as the producer price index and initial unemployment claims. There was also PMI data from the UK showing a contraction. The United States had a small increase in the number of new unemployment benefit claims, which shows that the labor market is still strong and tight.

In November, US producer prices rose a little more than expected. The annual inflation at the factory gate registered its smallest gain in 1-1/2 years, signaling a slowdown in the trend. 

Looking at the daily chart, it is clear that the price is in a bullish trend as it is trading above the 20-SMA, and the RSI is above 50. Bulls have consistently broken above resistance levels and are trading at the 1.2300 key resistance level.
Bulls have attempted to break above this key level but have failed. The second attempt is, however, looking weaker than the first. This could mean another failure. Bulls must gather more momentum to break above the 1.2300 key resistance level. If they don’t, bears might reverse the trend.

Another sign of weakness is the fact that the price is trading close to the 20-SMA. Bears must break below the 20-SMA to reach the 1.1850 and 1.1507 support level. 

Today, the Euro reached a nine-month high against the dollar as more hawkish remarks about European interest rates contrasted with market expectations for a more restrained Federal Reserve.
It was supported by Klaas Knot, an ECB’s governing council member, who stated that interest rates would increase by 50 basis points in February and March and then continue to rise in the following months.

Since Knot is seen as a hawk among decision-makers, the speech was interpreted as a response to recent claims that the ECB would reduce its rate of change to quarter-point increments starting in March.

In contrast, futures have steadily decreased the expected rate peak to a range of 4.75% to 5.0%, pricing out nearly any possibility that the Fed will rise by 50 basis points next month. 

This week’s scheduled flash surveys on manufacturing in January are expected to reveal bigger improvements in Europe than the US, in part due to declining energy prices. Furthermore, US inflation is declining further and quicker than the Fed estimates. The USD can drop even more this year in this scenario.

However, the new high is weaker than the previous highs, as seen in the RSI. There is a bearish divergence from previous highs that is pointing to weakness in bulls. Bulls will need more momentum to continue the bullish trend. Otherwise, bears might come in to reverse the trend.

Fed Chair Powell failed to deliver the kind of pushback against easy financial conditions that many had the right to expect in his speech yesterday, as the policy guidance was rather light in the speech. Most of the speech centered on a discussion of inflationary risks and where the Fed felt comfortable with the trajectory and outlook, and where it felt less certain, which was especially notable in the labor market/wage dynamics. The heart of the speech discussed the likely permanent reduction in the potential labor force due to older workers leaving the work force during the pandemic and the uncertainty of how quickly the wage pressures would ease. Near the end of the speech, Powell said “Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level. It is likely that restoring price stability will require holding policy at a restrictive level for some time.” The lack of certainty and Powell suggesting it may be appropriate to reduce the size of Fed hikes to 50 basis points at the December FOMC meeting emboldened the market. 
Soft US data added to the reaction function yesterday and helped US yields lower all along the curve, although this did not unfold until the market had a look at what the Fed Chair had to say. The November Chicago PMI plunged to a scary 37.2 (vs. 47 expected and 45.0 in October) and the November ADP private payrolls change were out at a 21-month low of +127k vs. the +200k expected. Today’s key event risk is the core month-on-month PCE inflation print, expected at +0.3% MoM and 5.0% year-on-year. Any upside surprise would sit very poorly with yesterday’s reaction, as would a stronger than expected November jobs and/or earnings data tomorrow.

USDJPY plunged down through the 137.50 area recent pivot low yesterday in the wake of Fed Chair Powell’s speech as US yields dropped all along the curve, with the US 10-year benchmark yield hitting 3.60%, a new local low ahead of the important 3.50%. The 200-day moving average, currently near 134.50 and rising rapidly, is zooming into view and will be a key test that might be hard to break unless US yields continue lower, which will be far more down to incoming data in coming weeks. The pain trade across markets now will be either a) stronger than expected US data and/or b) more inflationary data regardless of the strength in the real economy (that would require the Fed to remain higher for longer and for the market to eventually reset forward inflation expectations). Also watch global energy prices, a second source of vulnerability for the JPY due to its import of nearly all energy supplies. Some BoJ member jaw-boning overnight on an eventual policy shift also helping the JPY at the margin.

Gold price gained as the USD dropped deeper against its rivals. The metal is trading at $1,919 at the time of writing. 

The bias is bullish; that’s why the yellow metal could resume growth despite temporary drops. Fundamentally, the XAU/USD jumped higher after the US Consumer Price Index reported a 0.1% drop in December, while U.S CPI y/y came in at 6.5%, as expected.
Technically, the price of gold retreated a little. However, the outlook remains bullish despite temporary drops. After taking out the $1,879 resistance, the price action signaled an upside continuation.
After the US inflation data, the XAU/USD registered a false breakdown with a good trend below the $1,879 level. 

Fed Chair Powell failed to deliver the kind of pushback against easy financial conditions that many had the right to expect in his speech yesterday, as the policy guidance was rather light in the speech. Most of the speech centered on a discussion of inflationary risks and where the Fed felt comfortable with the trajectory and outlook, and where it felt less certain, which was especially notable in the labor market/wage dynamics. The heart of the speech discussed the likely permanent reduction in the potential labor force due to older workers leaving the work force during the pandemic and the uncertainty of how quickly the wage pressures would ease. Near the end of the speech, Powell said “Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level. It is likely that restoring price stability will require holding policy at a restrictive level for some time.” The lack of certainty and Powell suggesting it may be appropriate to reduce the size of Fed hikes to 50 basis points at the December FOMC meeting emboldened the market. 
Soft US data added to the reaction function yesterday and helped US yields lower all along the curve, although this did not unfold until the market had a look at what the Fed Chair had to say. The November Chicago PMI plunged to a scary 37.2 (vs. 47 expected and 45.0 in October) and the November ADP private payrolls change were out at a 21-month low of +127k vs. the +200k expected. Today’s key event risk is the core month-on-month PCE inflation print, expected at +0.3% MoM and 5.0% year-on-year. Any upside surprise would sit very poorly with yesterday’s reaction, as would a stronger than expected November jobs and/or earnings data tomorrow.

USDJPY plunged down through the 137.50 area recent pivot low yesterday in the wake of Fed Chair Powell’s speech as US yields dropped all along the curve, with the US 10-year benchmark yield hitting 3.60%, a new local low ahead of the important 3.50%. The 200-day moving average, currently near 134.50 and rising rapidly, is zooming into view and will be a key test that might be hard to break unless US yields continue lower, which will be far more down to incoming data in coming weeks. The pain trade across markets now will be either a) stronger than expected US data and/or b) more inflationary data regardless of the strength in the real economy (that would require the Fed to remain higher for longer and for the market to eventually reset forward inflation expectations). Also watch global energy prices, a second source of vulnerability for the JPY due to its import of nearly all energy supplies. Some BoJ member jaw-boning overnight on an eventual policy shift also helping the JPY at the margin.

As the Fed Chair Powell himself noted in a speech on inflation late last year, the key risk for further inflationary pressures comes from the labor-intensive services sector of the US economy, so arguably the ISM Services survey should carry plenty of weight today, together with the usual focus on payrolls and earnings growth, with the market leaning for the risk of stronger data today after a very strong December ADP Private Payrolls print 235k  and a revision of November data to 182k from 127k and with a very strong weekly claims number at 204k, the second-lowest print since May.

USDJPY is traditionally the most sensitive USD pair to US data, and would be even more so if any US data surprises add more volatility to the longer end of the US yield curve, as opposed to mostly seeing the market marking the front-end of the curve a bit higher or lower. The rally off the sub -130.00 lows has run into its important first resistance area  the pivot higher near 134.50 and near a prior pivot low back in early December. The next resistance area is the important 138.00+ resistance from early December, although the 200-day moving average comes in well below there at 136.50. To rise significantly above the 136.50-138.00 zone, we may need to see a more significant jump in longer US yields, not just the front end of the US yield curve.

Having a look at EURCAD today to emphasize the huge divergence in these two currencies in recent weeks. CAD is limping on oil prices rushing lower still after last week’s plunge after the news out of China over the weekend, with major oil grades trading at new lows today not seen since all the way back in January. The euro has enjoyed the tailwind of falling oil prices, the sense of emergency around gas prices this winter fading (however fragile the longer term outlook) and on the ECB getting more serious on signaling further rate tightening. Some of today’s boost in the euro may have come on ECB’s Klas Knot (widely considered at the hawkish extreme among ECB members) arguing that “To bring inflation back to target we will need a protracted period of time at which at least growth is below potential because otherwise we will never get the disinflation going.” Still, short EU rates were only a couple of basis points higher from Friday’s close. Can the pair go higher still? I suspect the answer to that is joined to the question of whether EURUSD can run higher still. So far, we have only seen a healthy correction after a tremendous slide in the euro, further euro- upside beyond another percent or two may get more difficult from here if a) US data remains persistently resilient and especially inflationary and b) if the developments in China begin to impact supply side constraints once again.