EURUSD fell by around 200 pips last week after the retracement topped in the 1.07-1.08 zone around the turn of the month. It has already fallen below the 1.05 level today (Mon), though a break below the 1.05 zone can’t be confirmed at the moment. 

Some support may emerge here around 1.05 since it was an important technical zone in the past. However, the sharp declines last Thursday and Friday suggest that it’s less likely this support zone will hold like in the past. And with EURUSD having already broken below the 1.05 level, it could soon reach 1.04 and attack the prior lows of 1.0350.

The support around 1.0350 is unlikely to be strong, as the low is rather insignificant in the larger historical context. Hence, the next important support area below 1.05 is parity (1.00), and it is what traders are likely to focus on. It’s also worth mentioning that the daily chart technicals (bearish channel) show that EURUSD could theoretically reach 1.00 by July 1.

To the upside, resistance remains rock solid at that 1.07-1.08 zone.

After correcting lower for 2-3 weeks, the US dollar rebounded strongly and (the DXY index) is now again nearing the yearly highs from May around 105.00. Most of the gains came on Thursday and Friday, incentivized by renewed risk aversion amid selling in global stock markets. 

Friday’s hotter than forecasted CPI inflation report provided the additional boost needed for the greenback to resume its uptrend. High inflation will keep the Fed firmly on its hawkish path. A 50bp rate hike is fully expected and priced in by the markets for the meeting this Wednesday. But the Fed will have the chance to send a more hawkish message via the dot plot economic projections and Powell’s press conference. Thus, the dot plot and the forward guidance will again be the key market drivers.

Chances are they will lean heavily on the hawkish side, which is why the dollar is already on the move toward the prior highs. With the strong economy and inflation at the highest in 40 years, the Fed has all the reasons to be aggressively hawkish. This will continue to be a major factor in supporting the USD this year. If the Fed delivers a hawkish message (perhaps by suggesting a 75bp hike is possible), then the USD could reach and surpass the highs from mid-May. This would likely mean that EURUSD slides below the 1.0350 low as well.

There are some economic reports worth watching on the US calendar this week. Retail sales, the Empire State manufacturing index (both on Wed), and the Philadelphia Fed manufacturing index (Thur) are in focus as important indicators for the health of the economy. Various housing data will also be released on Wednesday and Thursday.

The ECB delivered a hawkish meeting last Thursday, and yet the euro fell sharply by the end of the day. In a recent post, we discussed why the EUR is a lose-lose situation in the current environment, and that scenario now seems to be transpiring.

The culprit behind the EUR’s weakness are the rapidly widening bond yields between Germany and the Southern countries of the Eurozone (Greece, Italy, Portugal). When the ECB hikes rates, it increases the borrowing costs (bond yields) for countries. The problem for Europe is that borrowing costs are increasing much more and much faster for the highly indebted Southern members (Greece, Italy, Portugal) than for the northern states (Germany, the Netherlands). This is problematic because it reduces the ability of weaker (more indebted) Eurozone countries to pay back their debt. This is not a good scenario for the currency as its spurs capital to flee the region and is why the euro fell in spite of the hawkish ECB last week. 

The ECB can do something to help Italy and Greece by keeping their borrowing costs artificially low. However, that would include some form of partial QE, which is by itself bearish for a currency. Hence, the EUR’s lose-lose outlook. This dynamic will likely remain a dominant driver for the euro for the time being, and economic data and other developments may matter less. The euro is unlikely to gain much traction over the summer months, and the path to parity for EURUSD seems intact.