EUR/USD in Free-Fall as Soaring US Yields Boost US Dollar Ahead of Fed. Now What?

EUR/USD OUTLOOK:

• EUR/USD sinks on Monday, reaching its lowest level in more than a month
• Soaring U.S. Treasury rates boost the U.S. dollar and weigh on lower-yielding currencies
• Traders appear to be positioning for a hawkish FOMC decision this week

Most Read: US Dollar Forecast – Bullish Bias Intact ahead of FOMC, Hawkish Guidance to Boost DXY

EUR/USD sank on Monday, falling as much as 0.9% to 1.0420 at its worst point, hitting its lowest level in more than a month, pressured by broad-based U.S. dollar strength and risk-off sentiment. During the session, the DXY index briefly surged above the 105.00 mark, touching its highest level in more than 20 years, bolstered by soaring U.S. Treasury yields. Stocks also plummeted amid hawkish repricing of Fed rate hike expectations, with the S&P 500 dropping more than 3% and entering bear market territory, a move that reinforced safe haven demand.

Wall Street appears to be positioning for the possibility of more vigorous FOMC monetary policy tightening following higher-than-expected U.S. CPI data last Friday. Policymakers are expected to deliver a half-point hike on Wednesday, but bets are rising that the bank could surprise investors with a 75 bp adjustment in light of the latest developments on the inflation front. As of this morning, the probability of the latter scenario has risen to 28% versus 3.1% one week ago according to the CME FedWatch Tool.

FEDWATCH TOOL

Source: CME Group

Personally, I think the Federal Reserve will stick to the script and raise borrowing costs by the amount it telegraphed to avoid creating more uncertainty or being seen in “panic mode”. However, forward guidance is likely to be much more aggressive than discounted amid broadening inflationary pressures in the economy. With average gasoline prices hitting a fresh record in June and up more than 10% on a monthly basis, headline CPI could exceed 9% this summer, reinforcing the need for more forceful measures before expectations become unmoored.

Against the current backdrop, the Fed could indicate that it will front-load tightening in 50 bp increments through the end of the year or that it will step up the size of rate hikes at upcoming meetings, bringing into play jumbo 75 bp adjustments for the second half of the 2022, something we haven’t seen in 28 years. This hawkish outlook could accelerate the advance in U.S. yields, creating a bullish environment for the U.S. dollar. For this reason, the euro is likely to remain subdued in the near term, raising the risk that it could retest its 2022 lows in the coming days or weeks.

EUR/USD TECHNICAL ANALYSIS

EUR/USD deepened losses at the start of the week, breaking below a key area of support near 1.0500, a bearish signal for price action. If the pair closes below this level decisively, we could see a move towards the 2022 lows at 1.0349 in the coming days. On further weakness, the focus shifts lower to exchange rate parity.

On the other hand, if dip buyers return and manage to spark a bullish reversal, initial resistance appears at 1.0500. If prices climb above this barrier, upside pressure could pick up pace, pushing EUR/USD towards the next ceiling around 1.0650.

EUR/USD TECHNICAL CHART EUR/USD

Chart Prepared Using TradingView