EUR/USD Down 3.75% in February. Due to a Reversal?

Inflation in the Eurozone keeps rising, undermining real interest rates as the ECB is seen as unwilling to keep hiking.

Euro Was Doing Fine Until the Last NFP

Since late September of last year, the euro has been experiencing a rally against the dollar. The move was primarily driven by expectations that the Fed was reaching the end of its hiking cycle. Meanwhile, ECB had been starting its own hiking program late and was expected to keep tightening for a while longer. The currency pair peaked slightly above $1.10 on February 1, following meetings of the ECB and the Fed, where the former hiked by 50bps and the latter by 25. The expectation would repeat in March, with the ECB hiking by another 50bps and the Fed by 25bps, potentially the first of the "couple" rate hikes that Powell talked about.

A blowout NFP in January showed tightening in the labour market and changed expectations. Everyone has been expecting a quarter-point hike from the Fed, but since then, expectations of a 50bps hike have been slowly rising while expectations for the ECB to hike by 50bps have remained relatively unchanged. Bond yields in the US have been drifting higher but 

remain stagnant in the EuroZone despite rising inflation.

Record Inflation But Still No Change to ECB 

As it stands now, markets are seen pricing in a terminal rate of 5.5% for the Fed, 5.0% for the BOE, and 4.0% for the ECB. Meanwhile, inflation in the Eurozone keeps hitting new record highs, suggesting the problem is far from under control. Despite the record inflation in January, ECB's Lagarde affirmed that there would be a 50bps hike at the next meeting. Some analysts point to the similarities with the UK, where the BOE hiked relatively slowly, and inflation kept rising.

Recent commentary has also shaken confidence that the ECB will do what it takes to get inflation down. The recently published minutes from the last meeting revealed that some members were worried that there was too much focus on core inflation. Unless the rhetoric out of the ECB changes, or it delivers a convincing hike at the next meeting on March 16, the euro could be under increasing pressure as the ECB is seen as light-hearted in tackling rising inflation compared to the Fed despite US inflation coming down already.

Potential H&S in EUR/USD

On February 27, EUR/USD bottomed out at $1.0533, marking an 8-week low before experiencing an upward spiral to $1.0691 on March 1. Since then, it has been relatively unchanged and volatile, but it may be due to forming the right shoulder of a potential H&S pattern with the head at $1.1033. 

If the pair crawls higher, it could meet resistance at 1.0736, the left shoulder peak. In the opposite direction, the neckline appears at $1.0483, and we could see either level hit first as it would offer no significant changes to the formation. However, breaking outside the peak first might invalidate the pattern and open the door to $1.08363. In the opposite direction, losing the support will expose $1.0370.

Source: Spreadex

Key Takeaways

EUR/USD lost 3.75% in February, and expectations surrounding ECB and the Fed monetary policy have led to speculation that the ECB is not taking decisive action to curb inflation. The euro may be under increasing pressure if the ECB does not change its rhetoric or deliver a convincing hike later in March.