The EUR/USD pair ended the trading week at 1.0898. Considering that the pair opened Monday at the level of 1.0949, we came to the conclusion that the US dollar strengthened during the week. This is both true and not true. The greenback certainly strengthened its position amid fading dovish expectations and increased risk aversion. However, the dollar hesitated against the euro. For instance, the EUR/USD bears failed to settle below the support level at 1.0850 (the lower Bollinger Bands line on the daily timeframe, coinciding with the upper band of the Kumo cloud). The bears retreated after testing this target, making it possible for the bulls to approach the 1.09 level.
The fact is that the pair has witnessed a mixed fundamental picture. On the one hand, the Federal Reserve, through some of its representatives, has said that the central bank is not in a rush to lower interest rates. At the same time, the European Central Bank has cast doubt on the appropriateness of lowering rates within 2024. Therefore, there is no talk of a divergence in the positions of the Fed and the ECB at the moment - the scales are in balance.
For instance, Christopher Waller, a member of the Fed Board of Governors, said that the central bank needs to ensure that inflation is moving down sustainably before considering cutting the policy rate in 2024. Raphael Bostic, the President of the Atlanta Fed (who has a voting right this year), also mentioned that he is open to changing outlook to rate cut timing, as he warned that the progress on inflation is likely to slow in the coming months.
Bostic said he currently doesn't expect policymakers to cut interest rates until the third quarter, but they need to be careful not to lower the rate prematurely, risking a price spiral. Loretta Mester, the President of the Cleveland Fed, also voiced a similar position. She believes that the Fed is not yet ready to lower the interest rate, as the central bank needs more evidence that the U.S. economy is moving in line with expectations.
The market's reaction did not take long: the probability of a Fed interest rate cut at the March meeting dropped to 46% (according to the CME FedWatch Tool). It is worth noting that just three weeks ago, before the New Year, this probability was approaching 80%. However, the unexpected acceleration in overall inflation (CPI rose to 3.4% in December) had an impact. The Fed "hit the brakes" and warned the markets that it is not in a rush to lower rates. However, the dovish sentiment in the market, while weakened, still persists - for instance, the probability of a 25-point rate cut in May is 50%, and a 50-point cut is 33%.
This is an important moment because ECB officials continue to show hawkish rhetoric. Some of them even question the feasibility of rate cuts this year. Francois Villeroy de Galhau, Tuomas Valimaki, Gediminas Simkus, Klaas Knot, and Bostjan Vasle - all of these ECB members have said that it is not advisable to rush monetary easing, and the rate trajectory anticipated by markets (i.e., in spring of this year) "may be doomed to failure." The head of the Austrian central bank, Robert Holzmann, even said that rate cuts in 2024 aren't guaranteed.
ECB President Christine Lagarde was not as categorical in her conclusions, but she hinted at possible summer rate cuts. Lagarde said that eurozone inflation is not where the ECB wants it, but added that "it is likely that we will cut rates by the summer", provided that all necessary conditions are met.
Therefore, the situation remains uncertain: the Fed has supported the greenback, while the ECB hasn't abandoned the euro. As a result, the bears could not sustain the downward movement, and towards the end of Friday, they lost their initiative.
Other fundamental factors also have a mixed nature. For instance, last week, Iran and Pakistan exchanged missile and drone strikes, significantly increasing geopolitical tension. However, firstly, the strikes were not directed at state facilities, and secondly, both sides decided to reduce tensions on Friday - the countries announced a reconciliation, which was publicly reported.
At the same time, the situation in the Red Sea remains tense. The United States launched strikes on Houthi military targets in Yemen. The day before, the Houthis fired two anti-ship ballistic missiles at the M/V Chem Ranger tanker owned by the United States. Despite the U.S. strikes, Houthi representatives promised not to back down – they said that they would continue to attack ships connected to Israel, Britain, or the United States in the Red Sea and the Gulf of Aden.
In other words, the situation is unfolding with the prospect of further escalation. However, while the tension between Iran and Pakistan had a significant impact on the greenback, the U.S.-Houthi standoff is secondary of importance in the context of the currency market.
China also left a mixed impression. Official data showed that China's economy grew 5.2% on the year in 2023. The world's second-largest economy expanded at a 4.9% annual pace in July-September. However, the fourth-quarter result fell short of the projected value (most experts expected a growth rate of 5.3%). In quarterly terms, China's GDP lost momentum and grew by 1.0% (in the third quarter, it increased by 1.5%). Retail sales data also entered the "red." Sales in China increased by 7.4% in December year-on-year, missing expectations for an 8% growth.
Chinese exports increased by 0.6% last year, while imports decreased by 0.3%. Industrial production in China increased by 4.6% last year, retail sales grew by 7.2%, and capital investments in fixed assets increased by 3%. All these indicators were in the "green," exceeding forecasted values.
In my opinion, we can't say that China turned out to be a total disappointment. However, at the same time, China hasn't "inspired" either, as many analysts believed that there would be an economic boom in China after relaxing COVID-19 restrictions. However, the economic recovery has slowed down. The safe-haven dollar couldn't strengthen its position against such mixed conclusions, demonstrating only a short-lived reaction to the data.
Therefore, the pair remains at a crossroads. The recent round favored EUR/USD bears, but the "overall score" is still even. In order for the price to fall further, the bears need to consolidate below the support level of 1.0850 (the lower Bollinger Bands line on the 1D chart, coinciding with the upper boundary of the Kumo cloud). On the other hand, the bulls need to settle above 1.0930 (the Tenkan-sen line on the same time frame) to push the pair towards 1.0960 (the Kijun-sen line) and ultimately 1.1050 (the upper Bollinger Bands line on the daily chart).
