EUR/USD is the most popular and liquid currency pair. Investors hurried to buy EUR/USD last October when the exchange rate dropped below 0.96, as the psychological parity level, failed to provide support anymore.
The pair rallied strong, ending 2022 over one thousand pips higher, at 1.07. So comes 2023, and EUR/USD jumps another three big figures (i.e., three hundred pips points) and trades above 1.10.
The weak dollar was to blame, said some. Some others argued that the European Central Bank would have to raise rates to fight stubbornly high inflation. At the same time, the Federal Reserve will pause or even pivot, and so the EUR/USD should keep rallying.
But here we are, four-and-a-half months into the trading year, and the EUR/USD exchange rate is going nowhere. If anything, it approaches 1.07, the opening level for the year.
As it turned out, volatility in the FX market dropped in 2023 when compared to 2022. The only pairs that experienced higher volatility were the JPY pairs, as investors perceived the yen as a safe-haven currency and bought it during the US banking crisis that started in March.
But despite that, some see the EUR/USD as bullish as bullish can be. ING, for instance, raised its year-end forecast for the EUR/USD to 1.20.
Considering where the exchange rate is now (1.08 middle of May), a move to 1.20 in a little more than seven months should disrupt the FX market. Because remember? The EUR/USD is the most popular and most liquid currency pair of them all.
Euro area inflation shows signs of peaking
Sure enough, price stability is an issue in the Euro area. Yesterday, the April inflation report showed that YoY inflation is up 7% – way above the ECB target.
Hence, the logical steps for the ECB are to keep raising the key interest rates and to keep using a hawkish tone. At the same time, the Federal Reserve hinted at pausing the rate hikes.
From this perspective, raising the EUR/USD year-end target makes sense because rates will keep rising in Europe, whereas they are on hold in the United States.
But looking beyond the headline, one can see that Euro area inflation shows signs of peaking. Still timid ones, but if they will materialize, then the ECB may stop well before the market thinks it will.
EUR/USD in a relatively narrow range since the start of the year
Following the rally in the last months of 2022, EUR/USD trades in a relatively narrow range – some six hundred pips from the lowest to the highest quote in 2023, with the opening levels in the middle.
In other words, both bulls and bears are looking for direction, as neither can take control. Therefore, perhaps it would be wise to wait for the market to move first and act second before jumping on the long trade wagon. Otherwise, the danger is to be trapped in a tight range for many more months to come.
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