EUR/USD Faces Overbought Conditions as ECB Rate Hike Expectations Shift, Focus on Euro-Area Inflation

The euro-dollar ascent was mostly a one-way move for most of July. After inflation eased to the slowest pace in more than two years, the dollar tumbled. With the Fed entering their blackout period before the July 26th FOMC meeting, the lack of hawkish pushback has allowed the dollar to remain vulnerable to further pain just ahead of the 1.1300 handle. Bullish momentum has cleared multiple hurdles but the 1.1350 level should prove to be rather strong.
While the end of the Fed’s tightening cycle appears to be in place, expectations are shifting that the ECB might not be that far from pausing their rate hiking cycle. Today’s comment from ECB’s Knot, a well-known hawk, suggested that they could be ready to pause in September and that it might hinge on the inflation data going forward.
All eyes will be on the Wednesday’s second reading of euro-area inflation.
The EUR/USD daily chart displays a potential bearish butterfly pattern. Point D is targeted with the 1.414 1.414% Fibonacci expansion level of the X to A move and the B to C leg. If dollar strength emerges here, downside could target the 1.1050 level.
If invalidated, bullish momentum could surge above the 1.1300 region, potentially targeting the 1.1450 resistance zone.
The plunge for dollar-yen accelerated after last week’s cooler-than-expected inflation report shifted Fed rate hike expectations. The macro backdrop has mostly seen investors calling for pain for the Japanese yen since 2021. Hedge funds ramped up bearish yen bets(according to the COT report for the week through July 11th), taking their net short positions to the largest level since last May.
Now the focus also includes the BOJ, which includes some disappointment with keeping the BOJ keeping Yield Curve Control intact. Yen volatility could remain excessive if the Fed signals more tightening might need to be done after the July 26th FOMC meeting and if BOJ doesn’t tweak their policy.
Over the next couple of weeks, it seems that the yen rally will either cool towards 141.50 (a temporary recovery) or we will see it surge below 136.00 (the downtrend remains in place).