EurUsd Weekly Outlook for August 7, 2023 – Farewell to Triple A, Credit Downgrade that Could Spell Good News for the Dollar

• The recent cut to American debt has disturbed the markets’ summer calm, stirring up turbulence. US bond yields have risen above 4% due to increased perceived risk, resulting in a slight strengthening of the dollar.
• The drop in producer prices in June is causing uncertainty about the European Central Bank’s (ECB) continued restrictive stance on interest rates. The data from August will be pivotal.
• EurUsd continues to trade within a range, with the key support zone of 1.08 now in sight. Only if it falls below this level will we have clearer indicators about the future direction of the exchange rate.

The Credit Rating Cut That Could Benefit the Dollar

In South America, efforts to combat inflation appear to be successful. In order to ward off a potential recession, several central banks that had significantly raised interest rates in previous months are now choosing to decrease the cost of borrowing. Chile and Brazil are leading this charge, which many in the market hope will become the trend for central banks in 2024.

The downgrade of the US debt rating last week sent shockwaves through the markets, causing a fall in stock values, an increase in interest rates, and a temporary rally for the dollar. Fitch Ratings agency stripped the US long-term debt of its Triple A rating, a move seen as necessary, considering the ratio of debt to GDP and the current debt servicing costs. Without taking corrective measures, the agency forecasts a debt-to-GDP ratio for the US of 6.9% by 2025. Many are drawing parallels to 2011 when a similar downgrade by S&P500 caused markets to retract significantly.

With the Federal Reserve (FED) promising to continue raising interest rates, we may see this period of volatility extend throughout August. Recent US ISM manufacturing data confirms the ongoing economic slowdown, with the numbers again dipping below the 50-point mark. However, it was the latest employment data that validated concerns of an impending and more marked economic slowdown, with July’s payroll numbers falling far short of expectations. The FED has indicated that future decisions will be firmly based on economic data. Inflation will be the next key figure to watch. If it surprises us, we could witness significant fluctuations in the currency market. The upcoming end-of-August symposium in Jackson Hole is anticipated to provide greater clarity on the FED’s monetary policy.

Meanwhile, in Europe, the slowdown in inflation continues. Producer prices in June retreated by 0.4%, sounding several alarms about whether it’s wise to keep raising interest rates in Frankfurt, given the lesser pressure at the beginning of the production chain and PMI data that’s below the 50-point expansion benchmark. The dollar started a prolonged uptrend in 2011, and we’re seeing the first signs of a similar trend now. However, if this remarkable recovery of the American currency is to fully materialize, certain technical thresholds, which we’ll soon discuss, need to be breached.

Technical analysis – the dollar shows signs of life

In technical analysis, there are always warning signs that prompt us to reconsider our views to avoid being caught on the wrong side of market trends. The EurUsd has been guided in its rise since 2022 by the 150-day moving average, currently at 1.082. In March and then again in May, the currency pair managed to find support from the average to reverse its decline until it hit the 61.8% retracement of the total decline that began in 2021, forming a strong resistance. This peak has formed with three consecutive highs, with the third one exceeding the normal growth trajectory.

This pattern might serve as an excuse for those who use Wolfe waves (a variant from the common Elliott waves) to predict a EurUsd drop in the coming weeks. This becomes a scenario to consider if the dollar manages to surpass 1.08. In that case, a return towards 1.03 becomes a surprising, yet more likely target.

EurUsd’s current behavior mirrors that seen during the formation of the two most recent relative peaks. A weekly overbought situation is observed, which though diminished, has not dipped below the 50-point mark. This emphasizes the importance of the currency pair’s reaction to the crucial support zone around 1.08.