17.08.202309:33 Forex Analysis & Reviews: EUR/USD: dollar reflects resilience of US economy while euro's stability in question

The US dollar is once again in a dominant position, successfully overshadowing the euro. The dollar seems to mirror the strength and confidence of the American economy, which has showcased resilience so many times already. For the euro, the question of stability remains a challenging one. It had to prove its viability several times but not always with success.

The Federal Reserve's actions and the current macroeconomic statistics are crucial for the greenback's future trajectory. This is particularly in reference to the monthly reports released on August 16 by the US Census Bureau. According to recent data, housing starts in July increased by 3.9% month-on-month. Notably, there was an 11.7% decrease in this metric in June. This exceeded market expectations which had anticipated growth of 2.7%. Moreover, the number of building permits also increased in the past month by 0.1% after decreasing by 3.7% in June.

The US dollar did not show a significant reaction to this batch of macroeconomic data. The publication of the Fed minutes had a more pronounced impact on the dollar's movements. On the evening of August 16, prior to the report's publication, the greenback depreciated slightly against the euro. By the next morning, the dollar had appreciated slightly, positioning the EUR/USD pair close to 1.0883 and erasing some of its earlier gains.

From the technical point of view, in the middle of the week, the EUR/USD pair tried several times to breach the 1.0900 mark with varying degrees of success. Analysts believe that the pair could approach the lower level of 1.0800 very soon. According to the technical charts, the 20-day SMA is pointing downward and is positioned above the longer MA. Notably, bears have been selling the pair during its upticks. As for the Relative Strength Indicator (RSI), it continues to consolidate within negative levels, suggesting bearish risks.

The chart indicates that the EUR/USD pair is struggling to break out of the bearish 20-day SMA, which is accelerating its decline. Other technical indicators show a downward movement after failing to cross their median lines. This indicates a continuation of the downward trend, which could intensify if the nearest support level at 1.0870 is broken. However, the situation has currently stabilized, and the pair is holding confidently within its current range.

In the current landscape, the European currency remains susceptible to fluctuations. Notably, after the release of the Eurozone's economic data, the euro appreciated but later its growth stagnated. The combined GDP of the 20 Eurozone countries grew by 0.6% annually and by 0.3% quarterly in the second quarter of 2023. Both metrics were consistent with preliminary assessments. Moreover, in the first month of summer, the Eurozone's industrial production volume decreased by 1.2% year-on-year but rose by 0.5% on a monthly basis. This surpassed analyst expectations, predicting a decline of 4.2% and 0.1% respectively.

Post the Federal Reserve's minutes release, markets have gauged the prospects of the institution's future monetary policy. Earlier, the FOMC members expressed concerns regarding the current inflation levels and did not rule out further monetary policy tightening. However, the regulatory representatives were divided on the potential negative impact a prolonged tightening cycle might have on the US economy. Against this backdrop, the majority of analysts (86.5%) anticipate the Fed's rate to remain at the current range of 5.25%–5.5% in September. By the end of 2023, they foresee a possible increase to 5.5%–5.75%.

This situation has been favorable for the greenback. Following the release of the minutes from the Federal Reserve's July meeting, the US dollar considerably strengthened. USD was buoyed by market expectations of the regulator maintaining interest rates at relatively high levels. It is important to highlight that, during its July session, the institution raised its interest rates by 25 basis points to 5.25%–5.50%, marking the highest level since 2001. The meeting minutes revealed that the FOMC representatives view below-trend economic growth and a cooling US labor market as essential conditions for economic recovery.

According to the minutes, most central bank representatives perceive "significant inflationary growth risks." Against this backdrop, the question of further monetary tightening remains pertinent. FOMC members continue to believe that a slight easing in the labor market and some reduction in US economic growth are needed to restore economic balance.

Many experts fear that the Federal Reserve might increase rates again and sustain them at elevated levels for an extended period. However, such a scenario is beneficial for the US dollar, as it bolsters its strength. According to specialist evaluations, the FOMC minutes hint at further rate hikes, lending support to the American currency.

In the evolving scenario, economists at Scotiabank express concerns about a potential weakening of the dollar during the second half of 2023, as the monetary policy tightening cycle appears to have peaked. So market participants anticipate a gradual reduction in the Federal Reserve's rates. Concurrently, Scotiabank believes that the robust growth of the American economy might decelerate.

"The challenges faced by the US economy take a backseat in light of the persisting inflationary pressures in Europe. This circumstance promotes the maintenance of high rates in the United States and a potential increase in Europe. The current situation leads to prolonged adverse effects on risk assets but could potentially be favorable for the dollar. A narrowing of spreads might pose a downside risk for the greenback, but this is a solvable issue," the bank concludes.