EUR/USD Forecast: Further Retreat on Powell Talk and Position Adjustment

The euro is liable to drift lower in the short term with further month-end position adjustment. After some hawkish rhetoric from Fed Chair Jerome Powell and expectations of higher U.S. inflation underpinning the dollar, EUR/USD is liable to weaken to the key 1.2180 area with sharp losses if this support region breaks.

The Euro-zone economic sentiment index declined to 114.1 for February from a revised 114.9. Both industrial and consumer sentiment retreated slightly, although expectations of selling prices also increased.

Bundesbank head Jens Weidmann said there should be no reason not to end the EU's quantitative easing program this year, and it is important to gradually and dependably reduce monetary stimulus as inflation allows.

His statement had only limited impact because traders expected ECB President Mario Draghi to resist attempts to tighten monetary policy.

German consumer prices increased 0.5% for February which was inline with consensus expectations, although the year-over-year rate of 1.4%, down from 1.7% previously, was slightly below market forecasts of 1.5%.

Headline January U.S. durable goods orders declined 3.7% following a revised 2.6% gain the previous month and a weaker-than-consensus 2.4% drop. The annual gain was 8.9% however.  Underlying orders also missed consensus forecasts with a 0.3% decline.

The goods trade deficit was wider than expected with a $74.4 billion shortfall for January from $72.3 billion previously and the widest deficit since the current series started in 2015. Monthly exports retreated more than imports.

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In his prepared statement to the House of Representatives Financial Services Committee, Fed Chair Powell stated that further gradual interest rate increases will best promote the Fed’s inflation and employment objectives.

He also said that the Federal Open Market Committee (FOMC) would strike a balance between avoiding economic overheating and moving inflation to the 2% target on a sustained basis.

Near-term economic risks were described as roughly balanced, but inflation trends will be watched closely. In this context, higher inflation readings at the end of 2017 supported expectations that inflation would increase this year and that 2017’s decline was against the trend.

Powell also made comments that imply interest rates have room to rise.

Initial dollar gains on Powell’s statement faded as Treasuries reversed losses to move briefly into positive territory.  

U.S. consumer confidence strengthened to 130.8 for February from 124.3. This is the highest reading since November 2000. In addition, the Richmond Fed index strengthened to 28 from 14, the second highest reading on record, while price pressures continued to build.

In his question and answer session, Powell stated that recent data has increased his confidence that inflation will move higher and that the economic outlook has strengthened since December’s meeting.

Following this confident rhetoric, Fed Funds futures indicated around a 70% chance of at least three rate hikes this year.

Position adjustment will be an important feature over the next 24 hours with the potential for significant volatility surrounding month-end trading. Given the extensive net long, speculative Euro positioning in the CFTC data, there will be the risk of a further unwinding as bulls look to pare their exposure.

There is still no evidence of major stresses surrounding this weekend’s Italian parliamentary elections, although uncertainty will also increase the potential for an unwinding of long Euro positions into the weekend.