EUR/USD drops to near 1.0650 as hawkish Fed policy underpins risk-off mood, ECB policy eyed

• EUR/USD has slipped near 1.0650 as the risk-off mood has gained significant traction.
• Higher interest rate peak guidance and no absolute commentary on recession by the Federal Reserve have supported US Dollar.
• Accelerating Eurozone inflation expectations are expected to force European Central Bank to hike interest rates by 50 bps.
• EUR/USD is expected to remain on tenterhooks as upside seems capped amid sour market mood.

EUR/USD pair has corrected dramatically to near 1.0650 after failing to test the round-level resistance of 1.0700. The major currency pair failed to remain bullish on 50 basis points (bps) interest rate hike by the Federal Reserve (Fed) and the latter’s hawkish guidance acted as nail in the coffin. Recession fears in the United States have escalated as Federal Reserve policymakers see higher interest rate peak in their mission of achieving price stability.

S&P500 futures have surrendered their morning gains and are expected to extend Wednesday’s losses as the risk aversion theme has gained significant traction. US equities are expected to face immense pressure as higher interest rate peak will result in debt-laden firms facing higher interest obligations and therefore weak operating margins.

The US Dollar Index has reached to near 103.90 and is expected to extend its gains ahead as the risk-off impulse has improved safe-haven’s appeal. Meanwhile, the 10-year US Treasury yields are hovering around 3.5%.

The Euro is expected to display significant action after the release of the interest rate decision by the European Central Bank (ECB) ahead.

Federal Reserve’s hawkish guidance provides cushion to the US Dollar

The Federal Reserve was already expected to hike its interest rates by 50 basis points (bps) to 4.25-4.50% as United States Consumer Price Index (CPI) has softened meaningfully led by weakening prices of gasoline and used cars, and airline fares. But, what brought sheer volatility in the FX domain was the hawkish guidance, and commentary on recession and inflation peak by the Fed chair Jerome Powell.    

Although inflationary pressures have dropped significantly from its peak of 9.1% but combat against the former is not over yet. The road to 2% inflation target is still far and therefore, the Fed policymakers have pushed the interest rate peak to 5.1%. Fed chair Jerome Powell has promised that the central bank will keep policy restrictive till it achieves price stability. On inflation peak, Federal Reserve’s Powell cited that it is difficult to say whether inflation has peaked or not. Similar views have been heard about recession as the Federal Reserve believes that No one knows if we are going to have a recession or not."

Rising wages could be the next hurdle for Federal Reserve policymakers

Federal Reserve’s Powell hopes that an absence of slowdown in Average Hourly Earnings could be a threat to decelerating inflation as higher earnings will propel households to accelerate their demand. This would result in an extension in price growth of goods and services by firms. A rebound in the inflationary pressures could put us back to the square one.

Going forward, investors will keep an eye on United States Retail Sales data. November’s Retail Sales are expected to contract by 0.1% vs. an expansion of 1.3% reported earlier. A decline in Retail Sales might impact the US Dollar ahead.

Higher inflation expectations cements further rate hike from European Central Bank

Supply chain crisis in the Eurozone economy have not calmed yet as war tensions between Russia and Ukraine are still solid. This is expected to keep Eurozone inflation expectations solid ahead. The European Central Bank expects the inflation rate to remain above 2% for the next three years, reported Reuters. As runaway prices are still far from reaching conclusion, European Central Bank's (ECB) revised projections has put inflation "comfortably above" 2% in 2024 and "slightly above" 2% in 2025.

This is going to compel European Central Bank President Christine Lagarde to tighten its interest rate policy further to tame roaring inflation. A poll from Reuters claim that the European Central Bank will hike interest rates by 50 bps to 2.5% despite the trading bloc is certain to enter in a recession.

EUR/USD technical outlook

EUR/USD is auctioning inside the Rising Channel chart pattern, formed on a four-hour scale. The Euro bulls are driving the major currency pair higher swiftly. The 20-and 50-period Exponential Moving Averages (EMAs) at 1.0610 and 1.0559 respectively are aiming higher, which indicates more upside ahead.

The Relative Strength Index (RSI) (14) has not surrendered the bullish range of 60.00-80.00 yet, which signifies that the upside momentum is still active.