Euro under pressure by disappointing Eurozone fundamentals

Important calendar events

• JPY: SPPI
• EUR: German IFO Business Climate, M3 Money Supply, Private Loans, Belgian NBB Business Climate
• GBP: CBI Industrial Order Expectations
• USD: Advance GDP, Advance GDP Price Index, Unemployment Claims, Core Durable Goods Orders, Durable Goods Orders

USD

The dollar declined early on Wednesday and the index dropped to 104.1, but gained strength later in the day, rising to 104.3. US treasury yields on the other hand gained strength, providing support for the dollar, with the US 10-year bond yielding approximately 4.29%. 

Economic activity data released on Wednesday for the US were mixed overall and failed to support the dollar. Flash Manufacturing PMI data were disappointing, showing that the US manufacturing sector has entered contractionary territory. The Flash Manufacturing PMI index dropped to 49.5 in July from 51.6 in June, falling short of expectations of a 51.7 print. A reading below the threshold of 50 denotes industry contraction. The US Services sector, on the other hand, continues to expand. The Flash Services PMI index dropped to 56.0 in July from 55.3 in June, beating expectations of a 54.7 print. The US Services sector continues to expand at an increased pace. New Home Sales were disappointing though, dropping to 617K year-on-year in June from 621K in May, against expectations of 639K.

The dollar was little moved after US President Joe Biden announced his decision to end his re-election campaign on Sunday. Biden endorsed the candidacy of Vice President Kamala Harris for the Democrats. Republican former President Donald Trump, however, remains ahead at polls for winning the US elections in November.

One of the key factors that are driving the dollar right now is the US rate outlook. The US Federal Reserve kept interest rates unchanged at its policy meeting in June, within a target range of 5.25% to 5.50%, as expected. The US Federal Reserve has held interest rates steady since last July. 

Rate cut expectations in September are currently above 90%, putting pressure on the dollar. The uncertainty around Fed rate expectations is likely to continue in the coming months causing volatility in Forex markets.

US inflation has dropped to its lowest level in three years, raising the odds of a rate cut in September. Headline inflation cooled to 3.0% year-on-year in June from 3.3% in May against expectations of 3.1%. Monthly inflation shrank by 0.1% in June against the 0.1% growth expected. Core inflation, which excludes food and energy, rose by just 0.1% in June from 0.2% in May dropping below expectations of 0.1% growth. Signs that inflationary pressures are easing might induce the Fed to start cutting interest rates in September.

Final GDP data showed that the US economy expanded by just 1.4% in the first quarter of the year. Economic growth in the US is slowing down, falling considerably below the 3.4% expansion registered in Q4 of 2023. The US economy is expanding at an increasingly slower pace putting pressure on the dollar, as GDP data have shown expansion by 4.9% in the third quarter of 2023. 

Important economic data coming up this week that may affect the dollar include advanced quarterly GDP on Thursday and Core PCE Price Index data on Friday. Core PCE Price Index is the Federal Reserve's primary inflation gauge and may affect the Fed’s rate outlook.

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EUR

EUR/USD dropped below the 1.083 level on Wednesday. The currency rate declined as the Euro weakened more than the dollar. If the EUR/USD pair declines, it may find support at 1.080, while resistance may be encountered near 1.095.

Eurozone fundamentals released on Wednesday put pressure on the Euro. German PMIs missed forecasts on Wednesday, indicating that the EU’s leading economy is weakening. Germany’s manufacturing sector fell deeper into contractionary territory in July, with a print of 42.6, far below the threshold of 50 that indicates industry contraction and below June’s reading of 53.6. Germany’s weakening manufacturing activity was reflected in overall Manufacturing PMI data for the Eurozone, which fell to 45.6 in July from 45.8 in June missing expectations of 46.0. The EU Services sector fared somewhat better. The EU Services PMI index dropped to 51.9 in July from 52.8 in June against expectations of 52.9. The Composite Flash Eurozone PMI Index dipped to 50.1 in July, down from 50.9 in June, marking its lowest level in five months and driven primarily by the steep decline in the manufacturing sector.

The ECB kept interest rates steady at its monetary policy meeting last week, after lowering its Main Refinancing Rate by 25 basis points to 4.25% in June. ECB President Christine Lagarde has stated that the central bank’s policy will remain data-driven. Markets expect that the ECB will cut interest rates again in September. The central bank’s policy outlook, however, will likely depend on the progress of disinflation in the EU over the coming months. Eurozone inflation remains sticky and may slow down the pace of future rate cuts.

Eurozone inflation eased to 2.5% in June from 2.6% in May putting pressure on the Euro. Core CPI, which excludes food and energy, however, rose by 2.9% on an annual basis in June against expectations of a 2.8% print. 

The Eurozone economy expanded by 0.3% in the first quarter of the year, which was in line with preliminary estimates. GDP data for Q4 of 2023 showed that the Euro area economy was stagnant with a GDP print of zero. The EU economy contracted by 0.1% in the third quarter of 2023 and barely expanded in the second quarter by 0.1%, after contracting by 0.1% in Q1.

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GBP 

GBP/USD traded sideways on Wednesday, oscillating around the 1.290 level. If the GBP/USD rate goes up, it may encounter resistance near 1.304, while support may be found near 1.277. 

British business activity has increased according to data released on Wednesday, bolstered by the fastest manufacturing growth in two years. The British Flash Manufacturing PMI Index rose to 51.8 in July from 50.9 in June, against a 51.1 reading. A print above 50 denotes industry expansion and July’s data showed that the manufacturing sector is growing at an advanced pace. The British Services sector also expanded in July, with a PMI print of 52.4 versus 52.1 in June. 

The BOE kept interest rates steady at its latest monetary policy meeting in June. The BOE maintained its official rate at a 16-year high of 5.25. Markets are pricing in a BOE rate cut in September with approximately 80% probability, while a rate cut by November is fully priced in. 

The British economy is showing signs of improvement, reducing the odds of a dovish pivot by the BOE. GDP data showed that the British economy expanded by 0.4% in May following stagnation the month before and against expectations of 0.2% growth. Moreover, the British economy expanded by 0.7% in the first quarter of the year against initial estimates of 0.6% growth. The UK slipped into recession last year as the economy contracted by 0.3% in the final quarter of 2023. 

Price pressures in the UK are easing, raising the odds of a BOE rate cut by September. British headline inflation remained steady at 2.0% year-on-year in June, beating slightly expectations of a drop to 1.9%. Annual Core CPI, which excludes food and energy, also remained steady at 3.5% in June. British inflation has consistently been down to the BOE’s target 2% target since May, indicating that the BOE’s hawkish monetary policy has been paying off. 

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JPY

The Yen continued its bearish trend on Wednesday and USD/JPY dropped to 153.1. If the USD/JPY pair declines, it may find support near 151.7. If the pair climbs, it may find resistance near 158.8.

The Yen surged last week, raising intervention speculation. The USD/JPY had been trading close to a 38-year high when the Yen received a sudden boost, fueling reports that the Japanese government has once again intervened to support the currency. So far Japanese officials have not commented on those rumors, but many analysts believe that the sudden reprieve in the Yen’s downfall was engineered by the BOJ. Analysts estimate that the BOJ has spent approximately $38.4 billion this month to prop up the Yen.

BOJ officials had been attempting to boost the Yen, warning traders against speculative short selling of the currency. The BOJ intervened to support the Yen in 2022 and again this year in late April and early May, when USD/JPY surged above the 160.0 level. The recent sudden boost in the Yen was likely due to another round of Yen buying by the Japanese government and has served to drive the message home that the government will step in to support the currency when necessary. Fears of another intervention have been preventing speculative short-selling of the Yen in the past few days, and the currency has been moving in an uptrend. 

The Yen has been under pressure since the BOJ disappointed expectations of a hawkish shift at its latest meeting. The BOJ pivoted to a more hawkish policy at its meeting in March, ending its negative interest rate policy and raising the benchmark interest rate into the 0% - 0.1% range. The Yen continues to weaken as there is still a significant disparity between interest rates offered by the BOJ and those from other major central banks. BOJ Governor Kazuo Ueda has hinted that the central bank would ease its bond purchasing at the next meeting in July.  

Japanese official Toshimitsu Motegi stated late on Monday that the BOJ should start normalizing its monetary policy, through interest rate hikes. Motegi’s comments raised expectations of a rate hike at the BOJ policy meeting next week, boosting the Yen. While rate cut expectations in July remain close to 30%, markets anticipate that the BOJ will ease its bond purchasing program next week, gradually shifting to a more hawkish policy.

On the data front, inflation in Japan remains weak but rising. Headline inflation rose to 2.5% year-on-year in May from 2.2% in April. BOJ Core CPI rose to 2.1% on an annual basis in May from 1.8% in April, exceeding expectations of 1.9%. Rising inflation in Japan increases the odds of another BOJ rate hike later in the year. Tokyo Core CPI rose to 2.1% year-on-year in June from 1.9% in May against estimates of a 2.0% reading. 

Preliminary GDP data for Q1 of 2024 for Japan showed that the country has slipped into recession. Japan’s economy shrank by 0.5% in the first quarter of the year against expectations of a 0.3% drop. Japan’s economy registered a small expansion by 0.1% in the final quarter of 2023, showing that the country’s economy is shrinking. Recession concerns limit the odds of a BOJ hawkish pivot in the coming months.

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Written by:
Myrsini Giannouli

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