Weekly EUR/USD Outlook for May 20, 2024 – Inflation Weighs on the Dollar

• Inflation Rises, but Less Than Expected: Market optimism grows as hopes for repeated cuts in U.S. interest rates by the end of the year rise. Stock markets hit record highs while the dollar struggles, confirming market views.
• Europe’s June Rate Cut: June appears to be the month for a rate cut in Europe, potentially preceding the Federal Reserve. Meanwhile, the Eurozone economy shows some positive signs of recovery.
• EUR/USD Testing Resistance Levels: EUR/USD attempts to breach initial resistance levels, moving towards the upper end of a trading range that remains far from concluded.

U.S. Inflation Moderates, Boosting Euro Against Dollar

Inflation is aiding the euro, which is approaching resistance levels that, if breached, could trigger a rally for the single currency. We’ll delve into this more in our regular technical analysis section on EUR/USD.

As expected, the key market mover this week was the U.S. April inflation data. Monthly inflation rose by 0.3%, down from 0.4% in March, while the annual rate increased by 3.4%, slightly below the anticipated 3.5%.

This slight moderation was enough to satisfy the market, even as Federal Reserve Chairman Powell appeared more threatening than usual, stating that confidence in inflation returning to target has decreased compared to last year. However, he also reiterated that future rate hikes are unlikely. This ambiguity suggests the Fed’s desire to keep its options open, potentially deferring any rate decisions until 2025, especially with stock markets at record highs and core inflation stubbornly above 3%.

The primary catalyst for market reaction was the flat retail sales data (versus expectations of +0.4%). This spurred investor enthusiasm for the possibility of the Fed preemptively cutting rates to counter an economic slowdown. Excluding autos and gasoline, retail sales fell by 0.1%, triggering significant dollar sales.

Across the Atlantic, the belief that the ECB will cut rates in June is gaining strength. This would be the first of a series of limited moves for the rest of the year. The Eurozone’s recovery, although slow, continues with encouraging macroeconomic data. If the ECB acts in June, it will precede the Fed in cutting rates, an unusual occurrence in the short history of the ECB.

Technical Analysis: Euro’s Rally Faces Key Resistance

The euro’s recent rise could simplify the ECB’s task in June. By cutting rates, the central bank would have room to manage a potential decline in the euro’s value below key support levels we’ve previously identified. The 1.085 area is now crucial, as evidenced by the difficulty the exchange rate has in breaking through a resistance level that could open the way to 1.098, the March high.

The overbought signal from the RSI could be the first alert that the current rally is nearing its end. If this long lateral phase repeats its historical pattern, we might see the exchange rate drop after testing the upper boundary between 1.10 and 1.12. Therefore, potential bullish breakouts could represent yet another bull trap, prompting us to maintain caution before abandoning the dollar.

The following monthly chart shows the annual performance of EUR/USD. The ongoing trading range has resulted in a virtually flat outcome so far. Low volatility and uncertainty over monetary policy developments have favored those preferring the higher yields of U.S. dollars over euros. However, this inability of the greenback to advance further might conceal a prospective weakness that could benefit the euro if it breaks out of the trading range above 1.10/1.12.