Market Analysis: euro rally cools off against USD and GBP

The recent market meltdown has caused traders to question where to go from here. Tuesday’s bounce is a natural reaction following a significant pullback, but it doesn’t mean the turbulence is over. It’s likely markets will test the lows once again as there are still concerns to be resolved, especially with regards to the outlook of the US economy.

The stock market has been the main focus this week, but the FX space has also been seeing strong moves. The standout pair for a few weeks now has been USD/JPY, which first started to signal the turn in momentum almost a month ago, when the June US CPI came in lower than expected. The 25bps rate hike delivered by the BoJ also helped the Japanese Yen recover some ground as it undid some of the carry trade that has been fuelling the selloff in the currency in the past two years. Because of this, the Yen was one of the strongest currencies last week.

But another currency has been gaining ground in the shadows. Aside from the Yen, the euro has been strengthening against most major currencies these past few days. To some extent, the euro is considered the default currency to turn to when the dollar is underperforming, but there seems to be more to it than that. Given the ECB chose to cut rates much sooner than the Fed to give itself more wiggle room to act in the future, it could be that markets are playing into the rate differential expectations. Current pricing shows the Fed cutting rates by 103 basis points by year-end, versus just 63 bps from the ECB. This is also because the Fed’s current rate is higher, but nonetheless, more easing from the Fed would play in favour of the euro when it comes to rate differentials. 

This led EUR/USD to briefly surpass 1.10 on Monday for the first time since the beginning of year. The momentum has been unable to hold as the dollar has recovered some ground since then, but we could see further bullish appetite if the pair is able to hold above 1.09 over the coming days. There will be more crucial data released in the US next week, specifically the CPI data for July, do markets are likely to remain pretty sensitive no any further signs of cooling in the US economy. For now, it seems like the bias in EUR/USD has turned upwards as markets anticipate a more aggressive cutting cycle from Fed over the coming months as it tries to catch up.

EUR/USD daily chart

_{Past performance is not a reliable indicator of future results.}

Another euro pair that has been making moves is EUR/GBP which is up almost 2.5% in the past week. Historically it has been a very choppy pair, but the bullish drive in the euro has been attracting attention. Again, it may be that investors favour Lagarde’s pre-emptive cutting strategy over the Bank of England’s more lagging approach. That said, markets are pricing in less rate cuts from the BoE during the remainder of 2024, with only 41 basis points priced in. 

How both the Eurozone and the UK economy evolve will be key to determine the next drivers for EUR/GBP. The stronger-looking economy will likely end up on top, but the pair is likely to remain choppy going forward. So far, buyers have been unable to hold above 0.86, finding resistance at the same place it did in May. 

EUR/GBP daily chart

_{Past performance is not a reliable indicator of future results.}