Euro: Balancing pressures as Fed path repriced – OCBC

OCBC strategists Sim Moh Siong and Christopher Wong analyze the pressures on the EUR/USD exchange rate, noting it is influenced by French political-fiscal risks and a potential cap on US Dollar strength. European bond market turbulence suggests a more dovish ECB stance, while rising US yields reflect economic resilience. Despite over three Fed hikes being priced in, OCBC anticipates a moderate USD rally into the year-end.

The EUR faces downward pressure due to European bond market volatility, although safe-haven demand for the CHF is waning. Recent labor market data indicates softer hiring and wage growth, hinting at easing inflationary pressures from the labor market. If upcoming inflation data confirms contained price pressures, markets may adjust expectations for further interest rate hikes.

The EUR/USD pair remains the primary focus, with a moderate USD rally expected rather than an aggressive one. Expectations for an October Fed rate hike have declined sharply after several Fed officials indicated a lack of urgency in tightening policy and stressed the need for further data assessment before any action. Recent comments from senior Fed officials have led markets to favor a pause in October, with further tightening likely postponed until later in the year.

While geopolitical uncertainties and high US bond yields support the USD, the EUR remains under pressure. Gold gains momentum as it surpasses $4,150, benefiting from a pause in the USD rally and receding expectations for an October Fed rate hike. The upcoming French political developments, particularly whether the Socialists and Marine Le Pen's National Rally intend to oust the government over the budget, will be a key factor in the coming days.

The ECB's response to inflation running almost twice its target remains uncertain, as bond markets are already contributing to the tightening, leaving the ECB with a challenging dilemma.