The euro-dollar pair fell sharply on Monday, reflecting broad US dollar strength. Opening trades at 1.1598, the pair renewed a four-week low early in the European session. The decline occurred without any specific news catalyst and against a nearly empty economic calendar for EUR/USD. This suggests the market continues to digest last week's events — first and foremost the US CPI and PPI releases.
Recall that both inflation prints were ambiguous. At first glance, they are clear hawkish arguments: headline CPI accelerated to 0.4% month-on-month in August from 0.1% in July, and to 3.4% year-on-year. Headline PPI also rose notably: monthly growth accelerated to 0.4% (from 0.1%), while the annual rate jumped to 5.4% from 4.8%.
Yet the structure of the reports is not unambiguously hawkish. Core CPI did accelerate to 0.3% month-on-month, but its annual pace slowed from 2.5% to 2.4%. Core PPI actually slowed to 0.2% month-on-month from 0.3%. In other words, fundamental inflationary pressure has not strengthened uniformly. Moreover, a significant part of the PPI rise came from energy: energy prices jumped 4.2% month-on-month in August, and gasoline accounted for a large share of CPI's increase.
By Friday, when the CPI was published, the scales were roughly balanced. Traders digested the data and refrained from rushing to judgment. After the initial southward impulse, the pair returned to the 1.16 area and closed the week at 1.1599.
But on Monday, sellers launched a fresh attack and are trying to secure a close below support at 1.1550 (the middle Bollinger Band on the weekly chart). If bears keep the pair below that level, the market would receive a technical signal favoring further declines—initially toward the 1.1500 area and then to the next support at 1.1470 (the lower edge of the daily Kumo cloud).
The main fundamental driver of pressure on EUR/USD is the sharp rise in hawkish expectations about Federal Reserve actions. Market pricing now places the probability of a September hike close to 90%. Moreover, participants have begun to price in an additional 25 bp move by year-end — CME FedWatch puts the chance of that scenario at roughly 50%. In effect, the market is now playing not just one hike but the potential start of a new tightening cycle.
The question arises: how durable are these expectations? Aren't traders running, so to speak, "ahead of the locomotive"?
Recent inflation releases strengthen the case for a rate hike. However, the Fed cannot ignore the other pillar of its dual mandate — labor market conditions. There, the picture remains ambiguous: summer NFP prints do not provide the central bank with equally convincing grounds for tightening rhetoric. And although August's NFP was decent, it followed an extremely weak July report. In other words, the last two reports send the market (and thus the Fed) conflicting signals. Given that, the Fed could raise rates, but it is unlikely to take an "ultra-hawkish" stance and preannounce a sequence of further hikes.
An additional argument for the Fed's caution is the nature of the inflation. As noted earlier, much of the CPI and PPI acceleration came from energy: gasoline, diesel, and other fuel components rose amid Middle East tensions. Monetary policy can cool demand, but it cannot directly eliminate an external price shock. Therefore, the Fed must weigh the inflation structure and the risk of weakening employment if it tightens too aggressively.
Thus, in my view, market participants are largely getting ahead of events. Traders are already pricing an almost ideal dollar scenario: a September hike plus hawkish signals about further action (i.e., signaling another step before year-end). But against an ambiguous fundamental backdrop, it is hard to imagine the central bank delivering such unambiguous forward guidance — especially considering Kevin Warsh's stance on Fed communication. Long before his chairmanship, he consistently argued against overusing preannounced signals about future decisions, believing that such practice creates false certainty for markets and constrains the central bank's freedom to react to changing conditions.
As a result, EUR/USD traders may fall into a trap of elevated expectations. On one hand, the dollar received a powerful fundamental boost via a re-pricing toward hawkish monetary expectations. On the other hand, the higher market expectations climb, the higher the bar becomes for the Fed itself: a "mere" 25 bp hike may not be enough for the greenback to continue rising at the same pace. The market will need confirmation of further tightening in the Fed's accompanying rhetoric and forecasts.
Therefore, despite the obvious temptation to open shorts on EUR/USD (given the pace of the drop), the downside scenario is not yet confirmed. The current downward impulse is more emotional than structural, since the market is rapidly baking into prices not only the nearly certain September hike but also subsequent tightening — which so far remains only a scenario, far from guaranteed. The Fed must consider labor-market conditions, and after a contradictory sequence of NFPs the central bank has substantial reasons to be cautious.
All this suggests that a wait-and-see approach is currently most justified. Selling the pair purely based on an already-occurred impulse is risky: the risk/reward profile deteriorates while the probability of a corrective move increases.
