Can EUR/USD break above its recent range?
The ECB is expected to cut rates later today and the market is fairly sure that this is a certainty, there is a near 100% probability of a cut priced in by the market. The market is currently pricing in the prospect of two further rate cuts this year, and rates in the Eurozone are expected to end 2024 at 3.25%, compared with 4.84% for the US.
US economy weighs on the dollar
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Open account Try demo Download mobile app Download mobile appEven though the ECB is set to be the first of the major central banks to cut rates, the euro has been resilient today. EUR/USD is trading towards the top of its recent range, at $1.0877. The reason for this is not only because rate cut expectations for this year have been scaled back by the market in recent weeks, but also because of a weakening in the US economy. In the past week there has been a recalibration of US rate cut expectations. There is now a 67% chance of a rate cut from the Fed in September. A week ago, this was 45%, and this is limiting dollar upside, the dollar index is lower by 0.5% in the past week.
A pre-election rate cut from the Fed
A combination of weak economic data in the US, and signs from retailers that the US consumer could be slowing, particularly low-income consumers, is starting to push the market into betting that the Fed will cut rates before this November’s election. This is not a political move, the market is starting to think that a pre-election rate cut is needed for economic reasons, and before the Fed breaks something in the economy.
EUR gains a yield advantage
This contrasts with the Eurozone, where inflation and growth has been surprising on the upside. The contrasting fortunes of the US and the Eurozone is reflected in the spread between US and German 2-year bond yields, as you can see below. This spread has been narrowing, as German 2-year yields have been rising at a faster pace than US 2-year bond yields, and the spread is now at its narrowest level since last March.
This is fueling euro resilience into today’s ECB meeting. Unless the ECB is particularly dovish later today, which is unlikely, then this spread may continue to narrow. If this happens, then EUR/USD could break above the top of its recent range at $1.09 and target life above $1.10.
Chart 1: US and German 2-year yield spread
Source: XTB and Bloomberg
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