A deeper and sustained decline seems unlikely

• EUR/USD broke below 1.1100 support to print multi-day lows.
• The dollar extended its rally, although it lost some momentum later.
• Germany’s headline inflation rate surprised down in August.

EUR/USD added to Wednesday’s pullback and breached key 1.1100 support to hit multi-day lows on Thursday. The sharp decline in the spot came in response to an equally strong move, albeit in the opposite direction, in the greenback, taking the US dollar (USD) back above the 101.00 mark.

In fact, the US dollar (USD) regained ground amid further depreciation of the Japanese yen, selling pressure in the risk complex and the release of positive data in the US list, which saw Q2 GDP numbers and weekly requests exceeding expectations.

The pair’s daily retreat was also accompanied by a broad-based rise in US yields along the curve and German 10-year bund yields, all against a backdrop of continued speculation about interest rate cuts by the Fed next month.

Meanwhile, investors continued to watch for any signs of the size of the Fed’s most likely rate cut in September after Fed Chairman Jerome Powell suggested the time might be right to consider recalibrating monetary policy. Powell also noted that “barring any unexpected developments, the labor market is unlikely to add significantly to the upward pressures on inflation in the near term, and that the Fed does not want to see further cooling in labor market conditions.”

Speaking about cutting interest rates, Atlanta Federal Reserve Bank President Raphael Bostic said Wednesday that with inflation continuing to fall and the unemployment rate rising more than expected, the time may be right to consider cuts of interest, although he wants to be sure. before taking action.

Earlier this year, Bostic said he anticipated the Fed would only need to cut rates once this year, likely in the fourth quarter, but recently suggested he might be open to starting cuts sooner.

Reflecting these likely cuts, the likelihood of a 25bps rate cut in this Sept. 18 meeting is nearly 67%, according to CME Group’s FedWatch tool:.

Around the European Central Bank (ECB), its latest accounts showed policymakers saw no compelling reason to cut interest rates last month; however, they also warned that the issue may be revisited in September given the relentless impact of high rates on economic growth.

In recent comments, board member Klass Knot said the central bank could consider a gradual interest rate cut if inflation continues on its current downward trajectory. But, he added, more data will be needed before any decision on such a reduction in September. Knot also urged caution, noting that while there may be merit to easing policy, no decision is on the table yet.

However, the release of lower-than-expected CPI flash data in Germany in August could play against any cautious approach by rate-setters. Advanced EMU inflation figures are due on Friday, and a similar surprise could prompt ECB officials to begin seriously considering another rate cut at the Sept. 12 event.

In short, should the Fed choose to implement further or more substantial interest rate cuts, the policy gap between the Fed and the ECB could narrow over the medium to long term, potentially lifting EUR/USD. This is especially likely as markets expect the ECB to cut rates two more times this year.

In the long term, however, the US economy is expected to outperform Europe’s, suggesting that any long-term dollar weakness could be contained.

Furthermore, the further appreciation of the euro seems supported by position sizing. According to the recent CFTC report, net euro longs rose to levels not seen since early June, reinforcing the sustained bullish trend of speculators. Instead, commercial traders, particularly hedge funds, continued to maintain their net short positions, placing the contracts at multiweek highs. During the period under review, EUR/USD saw a fierce rally, effectively breaking through the psychological barrier of 1.1000 to reach new yearly highs amid renewed and significant slide along the US dollar.

EUR/USD daily chart

EUR/USD short-term technical outlook

Further north, EUR/USD is forecast to test its 2024 peak of 1.1201 (26 August), before the 2023 peak of 1.1275 (18 July) and the round level of 1.1300.

The next downside target for the pair is the weekly low of 1.0881 (August 8), ahead of the critical 200-day SMA at 1.0852 and the weekly low of 1.0777 (August 1). From here, the low of 1.0666 (June 26) comes out ahead of the May low of 1.0649 (May 1).

Meanwhile, the pair’s uptrend should continue as long as it holds above the key 200-day SMA.

The four-hour chart shows some growth in downward momentum over the last few hours. Initial resistance is 1.1201, ahead of 1.1275. Instead, there is immediate support at 1.1055, followed by the 100-SMA at 1.1046 and the 200-SMA at 1.0960. The Relative Resistance Index (RSI) pulled back to around 35.