The euro (EUR) has managed to reclaim some lost ground during Thursday’s European session, despite the broader bearish trend in the EUR/USD pair’s recent market movements. This recovery comes as risk aversion eases and following hawkish comments by the European Central Bank (ECB) President Christine Lagarde.
Robust US data highlight the strength of the US economy
The robust US Retail Sales data released on Wednesday exceeded expectations as they showed a 0.6% increase in December, which was much higher than November’s 0.3% uptick and above the market consensus of a 0.4% rise. The positive data highlighted the strength of the US economy and reflect the recent statements from Federal Reserve (Fed) officials, who have emphasised that is too early to start considering interest rate cuts. The Federal Reserve’s Beige Book further reinforced the strength of the US economy, highlighting increased consumer spending during the Christmas season, increased travel, and expanded credit card lending.
The prospect of potential Fed rate cuts seems to have diminished, as indicated by the CME Group Fed Watch Tool, which now shows a 63% probability of easing in March—down from levels above 70% earlier in the week. This recalibration aligns with the overall sentiment that the Fed still has work to do in managing inflation and does not warrant an immediate policy shift.
ECB President Lagarde’s comments boost the euro
While the strong US Retail Sales data initially boosted the US Dollar Index to one-month highs, the impact began to wane, allowing the euro to find some support.
In her address at the Davos summit, ECB President Christine Lagarde firmly rejected any aggressive rate cuts and hinted at the ECB’s dovish pivot, slated for the next summer. Her stance served to stabilise the euro and provided a counterbalance to the prevailing bearish undertones.
Geopolitical tensions pose risks
Despite these positive developments, geopolitical tensions pose a persistent risk to the euro’s recovery. News of Pakistan’s retaliatory attack on Iran, in response to Tehran’s offensive earlier in the week, has the potential to dampen investors’ appetite for risk, acting as a limiting factor on the euro’s upward momentum.
EUR/USD upside potential
The single currency’s recent resurgence has been fuelled by a combination of favourable economic data, central bank rhetoric, and easing risk aversion, but risks persist, including geopolitical uncertainties. However, according to BNP Baribas, the EUR/USD could push higher by year end. This is because the ECB may initiate rate cuts before the Fed, but these are anticipated to be much fewer than those by the US central bank. This difference in monetary policy paths could favour the EUR/USD. Additionally, BNP Baribas mentioned that Eurozone investors hold too many US assets, and if they change their investment strategies, reducing foreign debt purchases and increasing local asset holdings, then this will benefit the EUR/USD pair.
Looking ahead, market participants are awaiting further guidance from key events, including a speech by Atlanta Fed President Raphael Bostic, US weekly jobless claims, and housing data. These indicators are poised to offer insights into the future trajectory of the US dollar. Additionally, ECB’s Lagarde is set to take the stage again in Davos, potentially shaping market sentiment further.