EUR / USD
EUR/USD rebounded around 0.5% to trade near 1.1441 after softer than expected US inflation reduced expectations of further Federal Reserve tightening and weakened the dollar. Annual CPI rose 3.5%, below market expectations of 3.8%, allowing the pair to recover towards the 20 day SMA and 30 day VWAP around 1.1400. The daily RSI has improved to around 49 after previously reaching oversold territory, although EUR/USD remains below the 50 day SMA at 1.1500 and the 200 day SMA at 1.1600, leaving the broader trend neutral to bearish.
Despite the weaker inflation data, we expect the broader macro backdrop to remain supportive of the dollar. Rising tensions in the Middle East have pushed Brent crude above USD 85 per barrel, increasing inflation risks while posing a greater challenge for the eurozone as a major energy importer. At the same time, Fed Chair Kevin Warsh described the latest CPI report as only one data point, suggesting policymakers remain cautious about declaring victory over inflation. In Europe, concerns surrounding Volkswagen's restructuring plans and weaker growth prospects continue to cloud the outlook for the region.
Looking ahead, the 1.1480 to 1.1500 resistance area remains the key technical hurdle. A sustained move above this zone would strengthen the case for a broader recovery towards the 50 day SMA, while failure to break higher could see the pair retreat towards support around 1.1330. Today's US PPI data and developments in energy markets are likely to determine whether the recent recovery can extend, although markets continue to price around a 60% probability of a September Fed rate increase.
USD / JPY
USD/JPY remains close to forty year highs around 162, supported by the wide interest rate differential between the United States and Japan. Although softer US inflation briefly weighed on the dollar, the Federal Reserve continues to signal that policy is likely to remain restrictive, while the Bank of Japan is expected to proceed only gradually with further policy normalisation. We continue to see this divergence as the dominant driver of the pair.
Higher oil prices following renewed tensions around the Strait of Hormuz also reinforce the outlook for elevated inflation, supporting expectations that US interest rates will remain high while increasing pressure on Japan's energy dependent economy.
Technically, the pair continues to trade above the 20 day SMA at 162 and comfortably above the 200 day SMA near 158.1, although the daily RSI has eased to around 60 from stronger readings earlier in the month, indicating some moderation in momentum. Support around 162 remains an important level, with a break lower potentially exposing the 30 day VWAP near 161.6.
Reports that Japan's Government Pension Investment Fund is unlikely to alter its current investment strategy have also reduced expectations of stronger repatriation flows. While intervention risk remains elevated and speculative short yen positioning is still heavily extended, we continue to expect USD/JPY to remain supported while the interest rate differential continues to favour the dollar.
GBP / USD
GBP/USD has recovered around 0.4% over the past session to trade near 1.3414 after softer than expected US inflation reduced immediate expectations of further Federal Reserve tightening and weakened the dollar. The pair has returned to the important resistance area where the 50 day and 200 day SMAs converge around 1.3400, although the retreat from intraday highs near 1.3437 suggests sellers remain active ahead of the 1.3450 level.
Sterling has also been supported by the Bank of England's relatively hawkish stance. Policymakers continue to highlight persistent services inflation and strong wage growth, while stronger than expected UK GDP data has improved confidence in the domestic outlook. This has helped narrow the policy gap with the Federal Reserve following the softer US inflation release.
However, we expect the outlook to remain balanced. Brent crude above USD 85 per barrel continues to present inflation risks on both sides of the Atlantic, and Fed Chair Kevin Warsh has made clear that one softer inflation report is unlikely to alter the broader policy outlook. Markets continue to price around a 60% probability of a September Fed rate increase, limiting the scope for sustained dollar weakness.
A sustained move above the 1.3400 to 1.3450 resistance area would strengthen the case for a recovery towards 1.3498, while failure to hold above the moving average cluster could see GBP/USD slip back towards support around 1.3300. Today's US PPI release is likely to provide the next important directional catalyst.
