EUR/USD has finished the month of May in a much worse position than it was in the beginning of the month, as the US dollar has continued to strengthen on increased anticipation of a Federal Reserve rate hike this summer and the euro has fallen due to economic stagnation in the euro area along with a steadfastly dovish European Central Bank (ECB).
The ECB will announce its rate policy decision and hold its usual press conference on Thursday. Although the central bank is not widely expected to make any major changes to its policy stance, the possibility of further quantitative easing measures continues to be present. This possibility from a consistently dovish ECB remains a key factor in pressuring the euro currency.
For the US dollar, it continues to be a game of Fed-watching, and waiting. Last week, Fed Chair Janet Yellen reiterated in a speech that a rate hike in the coming months would be appropriate if economic data continued to improve as expected. This comment reinforced earlier speeches by other FOMC members that also took a cautiously optimistic approach to near-term monetary tightening, as well as the unexpectedly hawkish minutes of April’s FOMC meeting that were released two weeks ago.
US economic data as of late has indeed shown some continued signs of improvement, with a general increase in better-than-expected data points being released. The most recent case in point was Tuesday’s release of US consumer spending for April, which showed a 1% increase against prior expectations of 0.7%, for the largest monthly gain since September of 2009. But even more of a test of economic data improvement, of course, will be this Friday’s employment data in the form of Non-Farm Payrolls (NFP) for the month of May. In the run-up to the next FOMC meeting in mid-June, this release should be the last and most critical data input into the Fed’s June policy decision.
Outside of economic data, however, the still-present risk of a UK exit from the European Union, which will be decided by an upcoming referendum that takes place only slightly more than a week after the June FOMC meeting, could be sufficient to preclude a June rate hike from the ever-cautious Fed in favor of a potential July hike. Indeed, as of Tuesday, the Fed Fund futures market sees the probability of a Fed rate hike in June at only slightly above 20%, whereas the implied probability of a July hike remains elevated at nearly 60%.
Regardless of the specific timing of a rate hike, however, impending anticipation of Fed tightening has continued to fuel US dollar strength. This has helped lead to the sharp slide for EUR/USD throughout the month of May. Currently, the currency pair has rebounded modestly after having fallen to major technical support around the key 1.1100 level. Slightly below this support is the important 200-day moving average. With any further dovishness emanating from the ECB on Thursday and/or a robust NFP showing on Friday, a strong breakdown below this support could likely open the way for more losses and an extension of the slide since early May. In this event, the next major downside target continues to reside at the 1.0800 support level, followed further to the downside by the key 1.0500 support objective.