EUR/USD outlook has brightened by signs of peak US inflation

• EUR/USD outlook: Watch out for more signs of peak inflation and interest rates in US data
• European growth concerns linger, limiting euro’s upside
• EUR/USD technical analysis

The EUR/USD was a touch lower after Tuesday’s big rally. But more gains could be on the way as investors will be expecting the slowdown in US inflation will have much more to go as higher borrowing costs increasingly weigh on economic activity while housing rents slow further down in the coming months. Investors were awaiting the release of more US data later today, including retail sales, PPI and New York Manufacturing Index.

EUR/USD’s US CPI-related rally means short-term path of least resistance to upside

The EUR/USD enjoyed one of its best days in recent memory on Tuesday when it rallied more than 180 pips (+1.7%) as US inflation turned out to be weaker than expected. Other FX markets also enjoyed a strong day, including the GBP, commodity dollar and emerging market currencies, while US indices, gold and silver all gains ground as yields and the dollar dropped. The S&P had its best day since April. There has been further upside follow-through in some of these markets at the start of Wednesday’s session, although the EUR/USD was a touch lower at the time of writing, possibly because of a weaker industrial production figure from the Eurozone, while the sharper-than-expected drop in UK inflation also weighed on the pound, both helping to support the dollar index a little. However, following Tuesday’s price action, more gains could be on the way for foreign currencies like the euro in the short-term.

Tuesday’s big reaction across the financial markets suggests that investors have become significantly more hopeful that interest rates will start to go down from here, possibly starting by around the middle of next year as the Fed is starting to win the inflation fight. US CPI cooled to 3.2% YoY in October from 3.7% in the previous month, while core inflation eased to 4%. There was more good news on the inflation front in the UK this morning, with CPI here easing to 4.6% YoY in October from 6.7%, more than expected.

EUR/USD outlook: Growth concerns in Europe linger

Despite positive signs on inflation, growth remains a big concern for most European countries, which may limit the upside potential for the likes of the EUR/USD and GBP/USD in the longer-term outlook.

So, while it looks like the greenback may have peaked, the trouble for the dollar bears is that outside of the US, the global economy is struggling, which means that foreign currencies are not significantly more appealing than the dollar at this stage. Indeed, this morning delivered further Eurozone data disappointment: Industrial Production fell by a larger-than-expected 1.1% in September, more than wiping out the 0.6% gains made August.

Watch out for more signs of peak inflation and interest rates in US data

Moving forward, FX traders will want to see more evidence of peak inflation and interest rates in the US, if the likes of the EUR/USD were to make a more significant recovery than we have seen. The louder the “peak interest rates” narrative gets, the more support we are likely to see for the EUR/USD. Later today, we will have some more important US data to provide direction for the dollar. These include retail sales, PPI and Empire State Manufacturing Index. On Thursday, we will have industrial production, jobless claims and Philly Fed Manufacturing Index to look forward to, followed on Friday by building permits and housing starts.

EUR/USD outlook: Technical analysis

Source: TradingView.com

The BIG rally on Tuesday means momentum is now with the bulls. So, despite today’s slight weakness, the short-term trend remains bullish, and we will therefore be expecting dips back to former resistance levels to hold as support.

Ideally, from a bullish point of view, a bit of consolidation near Tuesday’s highs will be the best outcome, for that will confirm the bearish control has been lost. A bullish consolidation will allow short-term ‘overbought’ conditions to be worked off through time than price action.

The area around 1.08 is now the first level of defence for the bulls. Here, we also have the 200-day average coming into play. The next big level of support, should we get there, is around 1.0725-1.0755. This area was the previous resistance zone. But you wouldn’t want price to come back all the way to this level following Tuesday’s big move. If it does come back this deep quickly, then this will indicate to me that the bulls lacked conviction, which may lead to a breakdown.

On the upside, the 50% retracement level just below the 1.09 handle is the middle of the almost year-long consolidation range that the EUR/USD has been stuck inside. Should the bulls reclaim this zone, a move up to 1.10 handle could be on the cards next.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R

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