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Prospect of greater Fed, ECB divergence undermines EUR/USD

EUR/USD fell below the 10-DMA Monday and has nearly erased the entire rally induced by Fed Chair Jerome Powell’s less hawkish renomination testimony as investors leaned towards the Fed becoming more aggressive on rate hikes while the ECB remains accommodative.

Hot-running inflation continues to be a major issue for investors and oil’s LCOc1 rally to a 7 1/2-year high and ongoing supply chain issues reinforce worries that higher prices will persist.

Interest rate markets indicate investors expect the Fed will have to become more hawkish. Eurodollar prices EDH2 fell to a 22-month low while U.S. two-year yields US2YT=RR hit a 23-month high of 1.058%.

Interest rates in the euro zone are rising as well but at a slower pace. The down trend in Eurodollars out paces that of Euribor prices while German-U.S. 2-year spreads show the dollar’s yield advantage growing sharply.

Technicals highlight downside risks in EUR/USD. Daily and monthly RSIs imply downside momentum and the rising channel on daily charts suggests the rally off the late November low is a corrective move.

Should rhetoric at next week’s Fed meeting surprise investors with a more hawkish lean EUR/USD could fall very sharply.
Source: Reuters (Christopher Romano is a Reuters market analyst. The views expressed are his own)

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