The Purchasing Managers' Index of the eurozone unexpectedly dropped, while its American counterpart rose to a 13-month high in May. Will a break in the upward trend of EUR/USD come as a surprise? In the current situation, there is nothing to be surprised about. Against the backdrop of a strong economy, the continuation of the Federal Reserve's tightening cycle in July, following a pause in June, seems justified. However, the European Central Bank, amid a slowdown in eurozone GDP, may not do what the markets expect. This is extremely unpleasant news for the euro.
Dynamics of Business Activity in the U.S.
According to MUFG, the main reason for the strengthening of the U.S. dollar against major world currencies in May was the increase in U.S. Treasury yields. The retreat of recession fears after a strong employment report for April and the fading concerns about a banking crisis led to selling of debt securities. As a result, their yields increased. At the same time, the deadlock over the debt ceiling and the potential default are causing investors to demand higher yields on bonds.
The potential for its rally appears untapped, as the rates on 2-year and 10-year debts are below the Fed's established borrowing costs. They have room to rise, so the correction of EUR/USD will continue. If it is a correction. In the conditions of an unexpected slowdown in the eurozone's GDP and the first decline in the economic surprise index for the currency bloc since September 2022, it is not far from a break in the upward trend of the main currency pair.
Dynamics of Fed Rates and the U.S. Debt Market
MUFG believes that only the European Central Bank can save the euro. Only if Christine Lagarde and her colleagues raise the deposit rate by another 25 basis points in June and signal that it may increase to 4%, EUR/USD will recover some of its losses. Otherwise, the pair will continue to search for solid ground.
In my view, the hints from the Fed about a pause in the tightening of monetary policy, as reflected in the minutes of the May meeting, the slowdown in the April personal consumption expenditure index, and the lingering uncertainty about the debt ceiling will somewhat cool the enthusiasm of U.S. dollar bulls. This will allow the main currency pair to find support near 1.076 and start forming a consolidation range.
However, if the Federal Reserve turns out to be more hawkish than currently expected and inflation in the U.S. refuses to slow down, EUR/USD risks falling even further. Especially if a compromise between Republicans and Democrats on the borrowing limit is reached soon.
Technically, the formation of the Anti-Turtles pattern on the daily chart of the main currency pair suggests exhaustion of the corrective movement towards the upward trend. However, to activate it, breakthroughs of resistance at 1.0825 and 1.084 are required. Only the bulls' success in this endeavor will make it possible to buy EUR/USD. For now, we maintain the focus on selling.
