EUR/USD Forecast: Pullback from 10-Week High as Dovish Fed Caps Downside
By Kenny Fisher (Original source: Forex Crunch)
EUR/USD experienced a modest decline on Thursday, slipping 0.28% to 1.0879. This retraction came after a strong rally in recent sessions, with the pair reaching a 10-week high. Despite the pullback, downside pressure remained contained, largely due to dovish signals from the Federal Reserve that continue to weigh on the US dollar.
As traders digest the latest messaging from both the Federal Reserve and the European Central Bank (ECB), the EUR/USD outlook hinges on the divergent policy trajectories of the two central banks. Although recent moves have favored the euro, risks remain as both inflation data and central bank commentary continue to shape market expectations.
EUR/USD Market Overview
The euro has shown signs of strength in recent weeks, climbing steadily versus the greenback and touching its highest level since late September. This momentum was generated primarily by speculation that the Federal Reserve is nearing the end of its interest rate hiking cycle. At the same time, the ECB has also paused its own rate increases, though signals suggest a more cautious stance on easing.
Key factors contributing to the latest EUR/USD developments include:
– A more dovish Fed outlook, signaling no further rate hikes and potential cuts in 2024.
– Continued economic weakness in key eurozone economies, but with signs of stabilization.
– Inflation data on both sides of the Atlantic suggesting a downward trend, fueling expectations of looser monetary policy ahead.
– US initial jobless claims rising slightly, indicating a possible cooling in the labor market.
On Thursday, support for the US dollar came from modest gains in Treasury yields following better-than-expected retail sales data. However, the yield increase was not substantial enough to reverse broader USD weakness stemming from the Fed’s updated guidance.
Federal Reserve Signals Dovish Turn
The Federal Reserve maintained its benchmark interest rate within the 5.25%–5.50% range during its December policy meeting, as widely anticipated. However, the central bank’s revised Summary of Economic Projections (SEP) delivered a clear dovish pivot. The Fed now anticipates three rate cuts in 2024 as inflation continues to decline and real interest rates become more restrictive for the economy.
Key takeaways from the Fed’s recent policy update:
– The Federal Open Market Committee (FOMC) held rates steady for a third consecutive meeting.
– Median projections show an expected 75 basis points of rate cuts in 2024.
– The Fed’s Preferred inflation gauge, core PCE, is forecast to fall to 2.4% in 2024, easing toward the 2% target in the longer run.
– Fed Chair Jerome Powell acknowledged that rate cuts are becoming a topic of conversation among policymakers, signaling openness to looser policy in the near future.
While Powell emphasized data dependency and cautioned against premature rate cut bets, the market interpreted his tone as significantly more dovish compared to recent months. This led to a sharp drop in US Treasury yields and the dollar index, pushing EUR/USD to its 10-week high at 1.1017.
Market Reactions and Expectations
The market response to the Fed’s pivot was immediate. The two-year Treasury yield fell below 4.50%, its lowest level since late May. The ten-year yield also declined, extending the trend that began in early November. In foreign exchange markets, this drove broad-based dollar weakness and lifted major counterparts like the euro.
However, Thursday’s EUR/USD retracement shows that profit-taking and mixed data can still cause short-term volatility, even within a broader bullish trend for the pair.
Current market expectations include:
– Fed rate cuts could begin as early as the March or May 2024 meetings if disinflation persists.
– Market pricing now implies slightly more than three rate cuts are fully baked in for 2024.
– The ECB is also expected to
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