The EURUSD retracement has started, and the pair is already closing in on the 1.07 zone, which we’ve previously highlighted as the first key resistance to the upside. This 1.07 - 1.08 zone is a resistance that should keep the overall downtrend intact. A break above would give the first signs that the overall bearish trend is coming under threat.

Above 1.07 – 1.08, the next and final key resistance for the bearish trend is located at the 1.10 area. However, that is a more distant scenario, and for this week, it’s more likely that EURUSD will be held back below 1.08.

Support to the downside is now at 1.05, with the next one located at the 1.0350 lows.

The dollar corrected lower over the past week as overbought conditions combined with the economic data falling short of forecasts were enough to trigger a sentiment shift. The Empire State and Philly Fed manufacturing indexes were particularly ugly, while housing data and unemployment claims were also weaker. Taken together, those triggered a decline in US Treasury yields and the dollar.

With near-term sentiment now in a “corrective” mood, it looks likely that this US dollar retracement can extend a bit further. Sideways consolidation also looks like a probable scenario. That being the case, the long-term dynamics haven’t been altered, and the predominant bullish trend should remain intact. Fed communication is still firmly hawkish, and quantitative tightening (QT) and 50bp rate hikes will happen in the coming months. In contrast, other central banks fall significantly behind the Fed in terms of tightening policy. This divergence between the central banks should continue to support the USD and eventually extend the existing uptrend.

The Fed minutes (Wed) and PCE inflation (Fri) are in focus this week on the economic calendar. There are also numerous Fed speakers scheduled throughout the week. The durable goods report (Wed) and the preliminary GDP (Thur) will ALSO grab traders’ attention.

The FOMC minutes from the last Fed meeting will be scrutinized for the degree of tightening they are considering (whether more or less hawkish than currently seen by traders). It is perhaps the event that could cause the biggest market reaction. Still, that will depend on whether the report will reveal some surprises (which could jolt USD pairs swiftly) or confirm the Fed’s current stance (which would see a muted market reaction).

The euro recovered some lost ground last week, helped by the USD correction and some more hawkish comments from ECB officials. There was also no big negative news regarding the Russia-Ukraine war and European gas prices fell a little more, helping to stabilize the overly pessimistic EUR sentiment.

Comments from ECB’s Klaas Knot (hawk) that 50bp hikes could be on the table for the July meeting gained much attention in the news and helped to lift the EURUSD from levels below 1.05. There are also signs that ECB members are increasingly getting uncomfortable with the weakness of the currency, although so far, their concerns remain light (no mentions of intervention or other ECB actions). Still, this could be enough to get some bearish traders worried that EURUSD below 1.00 could inspire more ECB hawkishness and potentially a sharp rebound.

However, with all that being said, the overall weak EUR fundamentals remain in place. Unfortunately, the Ukraine war and the energy crisis in Europe are unlikely to end any time soon. Significant progress will be needed in those (and the Euro area economic prospects) before the EUR currency can stage a sustainable recovery. Thus, last and this week’s EUR rally is likely of corrective nature, potentially occurring before an eventual resumption of the trend down.

On the calendar, traders will watch the flash (preliminary) manufacturing and services PMIs tomorrow (Tue). These are still holding up relatively well given the negative environment of the Ukraine war, but potential disappointments here could arrest the EUR rally as soon as this week.