Q2 2024 EUR/USD Outlook: Will the ECB Start Rate Cuts Before the Fed?

EUR/USD Q1 2024 in Reviewinflation

In our full-year 2024 outlook, we highlighted that EUR/USD saw the second-smallest yearly range (828 pips) that it had seen since inception in 1999, and that low-volatility trade clearly carried over into Q1 of this year. Across Q1, EUR/USD traded in a tight, roughly 300-pip range under 1.10; the volatility was so limited that entirety of the Q1 range falls within the high-low range of each of the previous two quarters. This low volatility trade offered fewer trading opportunities than usual for most traders, but on the bright side, volatility is cyclical, so periods of low volatility and minimal market movement tend to be followed by periods of higher volatility and bigger market movements.

Will that be the case in Q2? Read on to see the key themes to watch!

EUR/USD Q2 2024 Outlook: The Case for More Aggressive ECB Easing

With economic growth, inflation, and employment all coming in stronger than expected across the developed world in the first three months of the year, a key theme for Q2 will be whether the economy falters, setting the stage for potential rate cuts at the either/both of the European Central Bank (ECB) and Federal Reserve (Fed).

As of writing in late March, traders are discounting a similar amount of easing on both sides of the Atlantic, with three 25bps interest rate cuts fully discounted by the end of December. At the margin, OIS traders are pricing in an incrementally higher probability of a fourth rate cut from the ECB (60% discounted) than from the Fed (20% priced in), but with how volatile those figures are, it’s hard to read too much into the small difference months in advance. In other words, much will ultimately depend on how economic data evolves and the temperament of the central bankers in question, but basic economic analysis suggests that the odds are skewed toward the more interest rate cuts from the ECB than the Fed, and therefore elevated odds that EUR/USD could start to fall as we move through Q2 2024.

To keep it as simple as possible, economic growth is likely to be higher and more resilient in the US than in the Eurozone, and inflation, the bogey that both central banks are trying to defeat, should be similar on both sides of the Atlantic over the next year. Starting with economic growth, the Organization for Economic Cooperation and Development (OECD) projects that the US economy will grow by 2.1% in 2024 and 1.7% in 2025. By contrast, the Eurozone is projected to see more anemic growth of just 0.6% and 1.3% in 2024 and 2025 respectively; these low growth figures leave the Eurozone more vulnerable to slipping into a recession if any negative economic shocks emerge:

Source: OECD

In perhaps a more timely, but less forward-looking, measure of economic activity, the US Composite PMI survey remains comfortably in growth territory (> 50) at 52.2 as of writing, whereas the equivalent measure for the Eurozone has been in contractionary territory (< 50) for nearly a year. This persistent divergence highlights the robustness and resilience of the US economy in the current market environment, bolstering the case for more gradual rate cuts from the Fed relative to the ECB.

Source: TradingView, StoneX

Shifting our focus to inflation, both the US and Eurozone are expected to see price pressures gradually recede toward the central banks’ 2% targets over the next couple of years. As the chart below shows, inflation in the Eurozone may be slightly lower than in the US over the next couple of years, marginally increasing the ECB’s confidence in cutting interest rates, especially against a backdrop of slow economic growth:

Source: OECD

When setting out a longer-term outlook, it helps to go back to basics, and from the most simple perspective, the European economy is growing more slowly than that of the US, with slightly lower price pressures. While both the ECB and Fed are likely to start cutting interest rates this summer, there is scope for more aggressive interest rate cuts from the ECB, a development that could weigh on EUR/USD as we move toward the middle of the year… and that’s before the more Eurozone-proximate risks from ongoing conflicts in the Middle East and Ukraine that could contribute to more euro downside if they escalate.

Euro Technical Analysis – EUR/USD Weekly Chart

Source: TradingView, StoneX

Looking at the weekly chart, EUR/USD sits almost exactly in the middle of both its 2023 range and its 3-year range as we enter Q2. After more than a year of consolidation, the odds of a stronger trend and more volatility have increased, but with no clear technical trend and tremendous uncertainty about the timing and quantity of interest rate cuts on both sides of the Atlantic, readers may want to wait for prices to break out one way or another before committing too strongly.

In terms of the key levels to watch, the 2023 range between 1.0500 and 1.1250 will be key. A bullish breakout above 1.1250 would expose the January/February 2022 highs in the 1.1500 area, followed by the 78.6% Fibonacci retracement of the whole 2021-2022 drop around 1.1750. Meanwhile, a bearish breakout below 1.0500 support could, in turn, have bears targeting the retracements of the 2022-2023 rally at 1.0200 (61.8%) and 0.9900 (78.6%), as well as the psychologically significant parity level at 1.00.

-- Written by Matt Weller, Global Head of Research

Follow Matt on Twitter: @MWellerFX