ECB decoupling to be tested – ING

EUR/USD’s decline this morning looks largely USD-driven, though admittedly the euro looks on less stable ground when considering the scope for harmonious repricing by the European Central Bank vis-à-vis the Fed, notes Francesco Pesole, ING’s FX strategist.

A retest of support 1,110 is possible

“Two-year USD:EUR OIS spread fell back below 100bp after Powell’s speech (now at 96bp). This could argue for EUR/USD above 1.12, but the softer risk environment favors some profit-taking and there could be some speculation that the rate differential should be re-examined.”

“Indeed, markets are pricing in a 50bp move by the Fed by the end of the year (100bp in total), but only 64bp by the ECB over the last three meetings through 2024. The investor community may not be consistently at ease with this decoupling of Fed-ECB rate expectations and risks are likely that some easing will be priced back into the ECB curve to realign with the Fed. Germany’s return to recession in the second quarter is a narrative that can contribute to this realignment.”

“EUR/USD may struggle to trade closer to 1.120 in the coming days as the lack of key US data likely favors the greenback and a retest of 1.110 support is possible. But we don’t see the conditions for the recent EUR/USD rally to be substantially reversed. From tomorrow, the Eurozone CPI numbers will start coming out, which will be a key test of that ECB-Fed decoupling story.”