EUR & USD Still a Buy Story & Levels to Watch

Dollar long positions are evaporating rapidly, with PPI numbers all but confirming the disinflationary narrative in the US. It's hard to find a clear counterargument against the bearish dollar momentum, but the move is looking stretched, so watch for potential temporary corrections. In Sweden, sticky inflation should keep the Riksbank hawkish.

USD: Army of bears growing stronger.

The 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. In my previous FX Daily report, 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. US economist observes that the crucial narrative regarding CPI and the PCE deflator in the future revolves around the ongoing normalization of corporate profit margins. 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.

In other central bank news, the Australian Treasury Minister, Jim Chalmers, has decided not to reappoint Philip Lowe as RBA governor and has appointed deputy governor Michele Bullock as the new head of the central bank. Bullock's recent statements align with the broader RBA messaging, emphasizing data dependency and leaning towards the hawkish side. She will assume her new role in September, but the immediate policy implications are expected to be limited.

On Friday, the DXY broke below the 100.00 barrier, and the next logical support level would likely be around 99.00. Given the significant swings observed in the past couple of days, a pause or an upside correction in the dollar could occur at any time. This morning's market movements suggest that we may witness some readjustment or stabilization today, with a relatively quiet calendar. Nevertheless, the dollar is expected to face prevailing downside risks in the near term.

EUR: 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.

As for the pound, this could lead to a retracement towards the 1.3050-70 range. Looking ahead, GBP is likely to face more evident downside risks compared to the euro. This is due to the greater potential for a dovish reassessment of rate expectations by the Bank of England in contrast to the European Central Bank's stance. The latest wage data suggested another 50 basis points hike in August, but the situation may evolve in the future.

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