Weekly Eur/Usd Outlook for September 30, 2024 – Euro Holds as U.S. Rate Cuts Loom

• The debate over how much the Federal Reserve will lower interest rates in the U.S. in the coming months remains unresolved. Markets are pricing in a substantial 175 basis point cut over the next 12 months, a highly aggressive measure that signals recession.
• Germany and France are teetering on the edge of recession, prompting Europe to question how fast interest rates will need to fall to combat an imminent economic contraction. Meanwhile, the euro has held its ground.
• Eur/Usd continues to hover around the resistance level of 1.12 without breaking through. This suggests that the market has yet to fully embrace the belief that the U.S. dollar is headed for a downturn.

Recession Hits Germany and France, Markets Bet on U.S. Rate Cuts

German and French PMI data confirm the ongoing slowdown in the Eurozone. Germany, already grappling with a recession, looks set to remain in negative territory for the second quarter of 2024. Surprisingly, France has also entered recessionary territory after the post-Olympics economic “hangover.” This contraction has dragged France’s economy below the key 50-point threshold that signals economic expansion.

In the wider Euro area, preliminary manufacturing PMIs have dropped below 45, while service PMIs are nearing the critical 50-point mark. With two of Europe’s largest economies veering into recession, there are growing calls for the European Central Bank (ECB) to act decisively on interest rates. Consequently, yields across the yield curve have been steadily declining.

Despite these challenges, markets remain bullish on the euro, anticipating that the U.S. will require a 175-200 basis point rate cut over the next 12 months—a drastic measure typically seen during deep recessions. Until the Federal Reserve offers more clarity on the future of rate cuts (or we see sharply deteriorating macro data), it seems unlikely that Eur/Usd will break through its resistance levels.

There are signs of cracks in the U.S. economy as well. Consumer confidence has slipped below 100, and financial conditions, as measured by the Chicago Fed, remain tight. However, with China signaling its intent to roll out substantial monetary and fiscal stimulus to spur growth, the risk for the Fed and Western economies could be losing the deflationary pressure that Beijing has exported for years. Chasing inflation again would be perilous, which is why we don’t rule out a more cautious stance from Fed Chair Powell in upcoming policy meetings.

Technical Analysis: Eur/Usd Struggles at 1.12 Resistance

Eur/Usd is once again testing the 1.12 resistance level, but the barrier remains formidable. The world’s most important exchange rate is attempting an ascent that seems counterintuitive, given that the interest rate differential still favors the dollar and European economic growth is slipping into recession.

Nonetheless, the market seems to continue betting that the U.S. slowdown will be sharper than expected, which implies a weaker dollar in the future. However, the euro’s rise is beginning to show signs of strain. Early divergences between rising prices and a declining RSI (Relative Strength Index) indicate that the rally may be overextended.

The importance of the levels between 1.12 and 1.13 is clearly illustrated in the chart below. The euro’s entire downtrend has retraced two-thirds of the way, marking the classic 61.8% Fibonacci retracement. It’s evident that the market hesitates in front of such a significant technical barrier.

This hesitation arises because breaking above this level would represent a major technical upgrade, requiring the market to be convinced that the dollar is entering a particularly negative phase. For now, such conditions are hard to identify, which could favor a near-term repricing of the dollar.