Since June last year, it has been rather one-way traffic for the euro against the dollar as the market focused a lot on the policy and economic divergence between the euro area and the US.
As much as European growth prospects were improving, the Russia-Ukraine conflict has certainly proved to be a reality check adding to inflation pressures and surging energy costs. The only real bright spot for the euro now is arguably the fact that the ECB has pivoted from its dovish stance to tee up rate hikes starting from Q3 this year.
That said, against the backdrop of a likely worsening economy, the window to tighten policy may only be a short-lived one. But that hasn't stopped markets from believing that the ECB can deliver rather aggressively. As things stand, money markets have priced in some 110 bps worth of rate hikes by the central bank for this year. That is at least four 25 bps rate hikes and will see the negative rates "experiment" in Europe come to an end - for now at least.
On that front, I would say that markets have "fully" priced in what the ECB can do this year but the same can be said for how markets are perceiving the Fed as well. The ECB's shift is arguably more monumental in terms of symbolism and that itself may lend to markets reacting more strongly as compared to Fed policy pricing.
But we'll have to take things slow and gradual on this one. A lot can still change by the time July comes and the risks could be skewed further on either side of the equation. For now though, the recent hawkish ECB rhetoric is doing the euro no harm at least.
For me, I'm also rather intrigued by the technical picture as seen above. EUR/USD had been pressured lower quite heavily in recent months and the drop from 1.1000 in April to 1.0400 earlier this month has come quickly. The dollar has been a roll and it might be time for a bit of a retracement, not least with the ECB officially confirming a shift in policy stance.
Adding to that is key support around 1.0400 with the December 2016 lows around 1.0340-66 helping to limit the latest downside momentum. That's a major level to have held and is helping buyers to find some breathing room for now.
I would argue given the fundamentals, a bounce towards 1.0800 is certainly plausible. But considering that the Fed is likely to face less challenges in tightening policy than the ECB, any extended rally towards 1.1000 is likely to be sold into. Of course, all of this depends on the inflation narrative in the coming months so data dependency is rather key to the outlook.
