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Misfortune helped bring happiness. It is unlikely that the euro, with its recession in the euro area, sluggish recovery in China, and the European Central Bank's quarter point rate hike in June embedded in the EUR/USD quotes, would have been able to counterattack if it weren't for the Federal Reserve's intention to pause. No one doubts that an announcement about it will be made in June. The weak inflation data, on the other hand, signals that the federal funds rate will not be raised in July. And that is very sad news for the US dollar.
The slowdown of consumer prices in the United States to 4% on an annual basis in May is only half the trouble. This growth is mainly driven by real estate prices. However, they will also start to fall in the near future due to statistical regularities. As a result, the CPI risks returning to 2% much faster than the Fed's forecasts suggest. So why raise borrowing costs at all in such a scenario?
The dynamics of inflation with and without real estate prices
There's more. The U.S. producer price index in May was the slowest in 2.5 years! In monthly terms the index decreased by 0.3%. Is the inflation epic in the US coming to an end? In 2022, the Fed was wrong about high prices being a passing phenomenon. Then it rolled up its sleeves to suppress them. And now, finally, the result is here. End the cycle of monetary tightening for now! What a pause. It's time to put a period to it.
If so, the bulls' enthusiasm for EUR/USD is understandable. Despite the recession that hit the eurozone at the turn of 2022-2023, the ECB is not going to stop. It's going to raise the cost of borrowing by 25 bps in June and by the same amount in July. The rate on deposits will rise to 3.75%. But it's not about its absolute value. It's about the extra steps that the ECB has and the Fed doesn't.
Betting on American exceptionalism indefinitely is not an option. Yes, the U.S. has a strong labor market, but many other macro indicators show that the economy is cooling. The Fed's most aggressive monetary tightening in decades could not have gone away. The U.S. is moving toward recession, while the currency bloc has left the recession behind.
Thus, divergences in monetary policy and economic growth are setting the stage for a recovery in the EUR/USD uptrend. It will have to wait if the Fed is more hawkish than expected at the end of the June meeting and the FOMC forecasts for the fed funds rate are raised. However, this will only delay the inevitable - the euro is destined to close 2023 higher than it is trading now.
Technically, on the daily chart of EUR/USD, the 1-2-3 reversal pattern clearly worked out. The idea of a rebound from the fair value at 1.0775 with the subsequent formation of long positions paid off handsomely. Now it remains to hold the longs and periodically increase them. The initial targets are 1.0925 and 1.0975.
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