FX Daily: EUR is at risk from dovish decisions at ECB meeting and firmer US CPI data
There are no ideal decisions for the EUR at Thursday’s European Central Bank meeting. Markets see a hawkish pause (consensus) or a dovish hike from a governing council divided over the Eurozone’s stagflation risks. On Monday, the European Commission’s latest forecasts showed that monetary tightening was working to lower inflation by slowing the economy. The commission sees Germany entering a recession. Yesterday, Germany’s ZEW current situation index dove to -79.4 in September, its worst reading since August 2020. The commission has downgraded the Eurozone’s GDP growth forecast to 0.8% from 1.1% for 2023 and dampened next year’s recovery to 1.3% from 1.6%. The commission lowered its CPI inflation forecast to 5.6% from 5.8% for 2023 but raised the 2024 projections to 2.9% from 2.8%. Hence, markets should not be surprised by any ECB decision to lift its 2024 inflation forecast above the 3% projected in June. Look for ECB President Christine Lagarde to reiterate her Jackson Hole’s warning that “the fight against inflation is not yet won.” Her goal will be to push back against the market’s rate cut inclinations in favour of keeping rates high for an extended period.
Conversely, the Fed is better-positioned to cool inflation with a soft landing in the resilient US economy. At the FOMC meeting in July, Fed staff stopped forecasting a US recession. Since then, the Atlanta Fed GDPNow model has raised its 3Q23 GDP growth forecast to 5.57% from 2.41%. At next week’s FOMC meeting, the Fed will probably lift its 4Q23 GDP growth forecast from the 1.1% pencilled in its Summary of Economic Projections (SEP). Today’s CPI data will provide clues on how the Fed will profile its inflation forecasts. Although the PCE deflator hit the SEP’s 3.2% forecast for 4Q23, it has risen again to 3.3% YoY in July from 3% in June. However, the PCE core deflator has held above the SEP’s 3.9% forecast; it rose to 4.2% YoY in July from 4.1% a month earlier. Today, consensus expects headline inflation to accelerate to 3.6% YoY (0.6% MoM) in August from 3.2% YoY (0.2% MoM) in July, but core inflation to slow to 4.3% YoY (0.2% MoM) from 4.7% YoY (0.2% MoM) on base effects. Barring surprises, the Fed should keep this year’s Fed Funds Rate projection at 5.6%, with interest rate futures looking for a final hike in September or November (consensus).
Given a more confident Fed vs. the ECB, we see EUR/USD maintaining its recent downtrend with the 1.08-1.0820 levels as opportunities to re-establish short positions.
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