The US dollar has been heavily affected by the disinflation narrative.
And upon examining the upcoming weeks leading to the July FOMC meeting, it appears that there are few data releases capable of significantly altering the situation for the greenback.
Recently, I drew a parallel between the current dollar sell-off and the one that occurred in December, highlighting how the dollar’s positioning was much more stretched towards the long side back then. This factor holds great significance, particularly considering the substantial post-CPI market movements, which indicate significant position squaring dynamics and suggest that the dollar’s positioning is now more balanced.
Considering this, it is challenging to construct a compelling counterargument against the bearish momentum of the dollar, especially after Thursday’s PPI data confirmed the dissipation of inflation in the United States.
If economic headwinds intensify, there could be potential for a significant contraction in margins (as companies engage in price competition), which could help drive inflation well below the target next year.
As CPI and PPI decelerate, it will be intriguing to observe how quickly inflation expectations decline. There are no scheduled speeches from Fed officials, as the pre-meeting blackout period has commenced. Surprisingly, James Bullard announced his departure from his role as President of the St Louis Fed on last Thursday. Although he has been one of the most hawkish FOMC members lately, the St Louis seat will not be up for voting until 2025.
Euro rally looking a bit stretched
The EUR/USD pair has experienced a surge due to disinflationary expectations in the US and a significant unwinding of dollar positions. My short-term fair value model indicates that the pair has now entered the territory of overvaluation (around 2.0%), signalling that the movement has surpassed what can be justified by market factors such as interest rates and equities.
As mentioned earlier, it is challenging to construct a compelling counterargument against the bearish narrative surrounding the USD at this point. While a correction after such a substantial and potentially excessive move is possible, the near-term outlook for EUR/USD may remain predominantly bullish.
In the eurozone, the calendar is relatively light, with only trade balance data for May scheduled and European Central Bank speakers on the agenda. EUR/USD could find stability around 1.1200 today or potentially correct lower towards the 1.1170-80 range, considering the current highly volatile environment.
Market commentary and analysis from Luca Santos, currency analyst at ACY Securities
