In determining currency exchange rates, the direction of movement of central bank rates is not the only thing important but also their potential to change. If back in 2015-2016, the ECB weakened monetary policy and the Fed tightened, the EUR/USD pair naturally fell. In 2017, Mario Draghi started talking about normalization and the market took this as a signal for euro purchases. Indeed, the growth potential of the refinancing rate seemed much greater than the federal funds rate. At the end of June, the single European currency strengthened against the US dollar on rumors that the ECB's potential for monetary expansion is far more limited than the Fed's arsenal. The US employment report should have answered the question of where we are going.
The rise of non-farm payrolls in June to 224 thousand allowed the EUR/USD "bears" to launch an offensive, although a modest increase in average wages by 0.2% m / m and an increase in unemployment from 3.6% to 3.7% slightly cooled their ardor. The actual increase in employment convinces that modest figures in May were normal market noise. Given the inflation being close to a target of 2%, the US labor market is still strong, which reduces the likelihood of Fed monetary policy easing in July. However, before the report of the Ministry of Labor, the CME derivatives were 100% sure that the federal funds rate was reduced by 25 bp and gave a 30% chance of falling by 50 bp.
Dynamics of the probability of the Fed rate change in July
The debt market was no less categorical and the 10-year bonds yield collapsed to its lowest level since 2016. Its differential with the federal funds rate continued to expand in favor of the latter, indicating a high risk of monetary expansion.
Dynamics of US bond yields and Fed rates
Simply put, investors were set up to take profits on long positions in the US dollar. However, American employment in June dissuaded them from the expediency of these actions. The US economy still looks better than the European one, the Fed is unlikely to lower the rate at the next FOMC meeting, while the ECB is seriously thinking about the reanimation of QE. Here, we do not need to talk about the potential for easing monetary policy, but about its divergence instead. That is, recalling the situation, the EUR / USD pair fell in 2015-2016.
What's next? I expect Donald Trump to increase his criticism of the Fed and sales of the pair on the rise, especially after the release of the minutes of the June meeting of the Open Market Committee. Then, let me remind you, there was the first dissident in the last few years, when they appeared to have an interest in lowering the rate, and Jerome Powell talked a lot about international risks. It's too early to get rid of the US dollar. Even if American and European GDP is slowing down, the United States still looks better than the Old World.
Technically, much will depend on the ability of the bears to pull the EUR/USD quotes outside the red triangle and keep them below the support of 1.1225. It turns out that there will be a chance to go to the area of 1.11-1.115. On the contrary, "bulls" can recover after a short consolidation to play the "Diamond-shaped bottom" pattern.
EUR / USD daily chart
