The euro hit a year-to-date low against the U.S. dollar on Tuesday after quietly trending lower for the past five weeks. Economic performance and monetary policy direction are the two most important drivers of currency flows and, in the case of euro, both have been calling for further weakness. EUR/USD consolidated above 1.1550 for more than a week before finally breaking lower, but even with today’s move, it is not a clear break, as the new low was only a few pips below last week’s low. For EUR/USD to sink to the next support level on the 1.13 handle, the pair needs a solid break of the psychologically significant 1.15 level.
On a fundamental basis, there are plenty of reasons for EUR/USD to underperform. There’s been a string of data disappointments from Germany and the Eurozone. PMI, factory orders, industrial production and today’s ZEW survey missed expectations. Investors are worried about the impact of rising energy costs and supply-chain bottlenecks on corporate profitability. On a monetary policy basis, the European Central Bank reduced PEPP purchases but its warnings against tightening too soon have investors looking for a rate hike in late 2023. Throughout this monetary policy cycle, the ECB lagged behind its peers. While it cut PEPP before the Federal Reserve tapered asset purchases, the Fed will surely lift interest rates before the ECB. So not only is EUR/USD pressured by softer data and a dovish central bank, but investors are bidding the greenback higher ahead of next month’s Fed meeting where a taper announcement is expected. The euro is weak against the dollar, but its underperformance is the most dramatic against sterling, the Australian and New Zealand dollars. EUR/GBP is down more than 2% from its September high, EUR/AUD lost value eight out of the last nine trading days, while EUR/CAD declined 15 out the last 16 trading days. Tomorrow’s Eurozone industrial production report should keep the downtrend intact as the decline in German industrial production signals weakness.
The U.S. dollar extended its gains against the Japanese Yen to fresh 2.5-year highs. Despite a nearly 3% decline in 10-year Treasury yields, the prospect of a strong inflation report tomorrow led investors to buy the greenback against the Japanese yen, Swiss Franc and euro. With ongoing supply-chain shortages and energy prices on the rise, CPI is widely expected to tick higher in the month of September. Since the beginning of the year, crude oil has risen more than 60%. Over the past 12 months, prices at the pump have increased $1. The cost of heating oil has also risen by more than 65% and this is filtering down to higher prices for other goods and services. Sooner or later, all of these price increases will cause material pain to consumers. The minutes from the last Fed meeting are due for release tomorrow and given the central bank’s readiness to announce taper, the outlook should be bright.
Sterling ended the day unchanged despite slightly weaker-than-expected employment growth. Stronger-than-expected average earnings and a lower unemployment rate keeps rate hike expectations for the Bank of England intact. Meanwhile, all three of the commodity currencies traded higher today. AUD led the gains following stronger Australian business confidence. The Canadian dollar was supported by oil, which held above $80 a barrel. Looking ahead, New Zealand business confidence and Chinese trade data are due for release this evening.