The euro continued its recovery against the US dollar on Monday, receiving support from more hawkish rhetoric coming from the European Central Bank (ECB). Just a day after the ECB's decision was seen as signaling the end of its tightening measures, several policymakers, including President Christine Lagarde, adopted a hawkish tone, stating that further interest rate hikes cannot be ruled out. This contrasted with market expectations of rate cuts in the coming year. Slovak policymaker Peter Kazimir also echoed this view, suggesting that they would need to wait for the March forecasts to confirm whether Thursday's rate hike was the last and that additional increases were still possible.
ECB Policymakers Push Back on Market Expectations
News that the ECB might soon begin discussing how to address the multi-trillion-euro excess liquidity pool, which offsets the impact of rate hikes by reducing competition for deposits among commercial banks, may have also boosted the euro. While the euro/dollar pair returned and closed above the key level of 1.0665, investors remain cautious, wanting more assurance that there will be no rate reductions next year. Currently, they are pricing in more than 50 basis points of rate cuts.
Euro Gains as ECB Officials Leave Room for Another Hike
The dollar traded cautiously on Monday as traders awaited the Federal Reserve's policy decision. Wall Street saw little change, and gold extended its gains. Investors may be placing more trust in upcoming economic data, as recent results have not been encouraging for the Eurozone. The preliminary PMIs for September, set to be released on Friday, could be closely scrutinized. If these indicators point to deeper economic challenges, even if inflation remains elevated, the euro could face renewed downward pressure. Market activity suggests that euro traders are more concerned about economic performance than high inflation, and worsening recession signals could lead to increased bets on rate cuts.
Dollar Traders Eye FOMC Decision
The dollar retreated against most major currencies on Monday but posted a slight gain on Tuesday. Traders may be hesitant to take significant positions ahead of the Federal Open Market Committee (FOMC) decision scheduled for the next day. The committee is expected to maintain current policies, with only around a 45% probability of another rate hike before the end of the current tightening cycle. Despite the relatively strong economic position of the US compared to other major economies, investors are still pricing in nearly 80 basis points of rate reductions for the coming year.
If officials refrain from raising rates, attention may turn to updated economic projections and the new dot plot. Given that recent data does not support the expected level of rate cuts, a dot plot indicating another rate hike by year-end and/or fewer rate reductions could further strengthen the dollar.
Wall Street Awaits FOMC Decision; Gold Rebounds Above $1,930
On Wall Street, both the Dow Jones and the Nasdaq closed with minimal changes, while the S&P 500 gained just 0.07%. Equity investors may have adopted a cautious stance ahead of the FOMC decision, as a hawkish outcome could negatively affect stocks, particularly those of high-growth companies whose valuations rely heavily on discounting expected free cash flows.
Gold capitalized on the retreat in the US dollar and Treasury yields, climbing above the $1,930 level. Even when the dollar was strong against other currencies and Treasury yields were rising, gold's performance remained relatively stable. This suggests that gold may be slowly regaining some of its safe-haven appeal.
Oil prices continued to rise following a report by the Energy Information Administration (EIA) stating that output from top shale-producing regions is on track to reach its lowest level since May. This adds to supply concerns driven by Saudi Arabia and Russia's decision to extend their production cuts.
