EUR/USD slips as stronger U.S. data revive Fed tightening risks

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EUR/USD slips as stronger U.S. data revive Fed tightening risks

Eurozone resilience keeps ECB tightening in play

The picture in the eurozone also remains relatively resilient, although the structure of growth is different. The Flash Composite PMI rose to 52.1 from 52.0, the highest since November, with the improvement in activity largely driven by manufacturing, especially in Germany. S&P Global estimates that such readings are consistent with eurozone GDP growth of around 0.3% in the third quarter, following actual economic growth of 0.4% q/q in the second quarter.

Germany also looks better than it did several months ago: its GDP grew by 0.2% q/q in the second quarter after revised growth of 0.4% in the first quarter, although domestic demand remains weak and the economy is sensitive to high energy prices. German inflation accelerated to 2.8% y/y in July, mainly due to the energy component, while core inflation stood at 2.4%.

Rate expectations turn less supportive for the euro

Against this backdrop, the divergence in ECB and Fed policy expectations remains in place, but it now looks less clearly favorable for the euro than it did a week ago. The market is almost fully pricing in a 25-basis-point increase in the ECB deposit rate to 2.50% at the September 10 meeting, with the probability of such a move estimated at around 95%.

At the same time, Fed expectations have become more hawkish after the strong PMI data: the probability of raising the target range from the current 3.50-3.75% to 3.75-4.00% at the September 16 meeting has increased to around 41-43%, compared with about 34% a week earlier. In other words, the euro still retains an advantage through the rate differential, but that advantage is narrowing as the market once again starts to price in the possibility of a September Fed hike.

Treasury yields reinforce dollar support

The U.S. Treasury market is providing additional support to the dollar. Today, the 10-year yield is around 4.71%, while the 30-year yield is near 5.24%, remaining close to multi-year highs. The expansion of Treasury buybacks and discussion of the possible use of Treasury General Account funds have so far failed to produce a sustained decline in long-term yields, as investors continue to demand a higher premium for inflation and fiscal risks, the scale of government debt supply, and strong demand for capital from both the government and the AI sector.

Therefore, as noted in EUR/USD strengthens on diverging ECB and Fed rate expectations, the short-term backdrop for EUR/USD is currently rather neutral-to-negative: as long as the pair remains below 1.1710-1.1680, pressure toward 1.1620-1.1600 is likely to persist. A return above 1.1700/10 would improve the technical picture again and open the way toward 1.1740-1.1760, while a break below 1.1600 would increase the risk of a deeper correction toward 1.1550-1.1520.

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