End of the cycle? Fed hold rates steady and EUR/USD rallies

Less than two months after the European Central Bank (ECB) failed to convince markets that it may raise interest rates again this year, the US Federal Reserve finds itself in the same boat.

Yesterday, 1^st November 2023, the FOMC opted to hold interest rates steady – reflecting a more cautious approach than members of the Fed had been signalling for the last month. Despite signs that the US economy is in rude health, the FOMC voted unanimously to avoid hiking rates again. Instead, many analysts see the Fed opting for a “wait and see” approach, hoping that the highest interest rates in 22 years will be enough to cool inflation over the coming year.

Ignoring the poor economic data coming out of Europe, the Fed’s decision to hold rates steady was more than enough to trigger a EUR/USD rally and a broader decline in the USD, as measured by the DXY index. 

The decision to hold rates steady was not a huge surprise. In recent weeks, policymakers and investment banks had noted that the bond market was doing the Fed´s job for it by tightening financial conditions through soaring yields. Deutsche Bank provided an estimate in late October, arguing that the recent sell-off in bonds has done the work of approximately “three 25-bp rate increases.”

In his statements to the press after the announcement, Jay Powell, Chair of the Federal Reserve, did attempt to leave the door open for further rate hikes, though markets remain unconvinced. “Overall, we think it is more likely that interest rates will not be raised further. This is because the central bank has been very cautious in recent weeks, despite some surprisingly strong data,” the Commerzbank research team noted in a statement. According to the CME Group FedWatch Tool, markets are currently pricing in a 20% chance that the Fed will hike again in December.

So it seems that we have come to the end of the rate-hike cycle, but the question now is how long the Fed will hold rates at the current level before starting to lower them. Many analysts fear a so-called “hard landing” next year, as the cost of borrowing starts to squeeze US companies and consumers. Torsten Slok, chief economist at Apollo Global Management, said the implications of higher borrowing costs should not be underestimated. “Ultimately, Fed hikes and tighter financial conditions will continue to increase delinquency rates for consumers, increase default rates for companies and put downward pressure on loan growth.”

However, other analysts worry that the Fed has not done enough and that inflation will rebound following the pause.

All eyes now turn to the NFP release this Friday, November 3^rd, which will give a better idea of the health of the jobs market. For now, the USD remains vulnerable, and any signs of a weakening in the US economy will weigh heavily on the currency.

Technical Analysis

On the technical front, the dollar began a sharp retreat on Wednesday, after a daily high of 107.00, closing at 106.44. The long upper wick and gap-lower opening on Thursday added to the downward pressure, as the price heads towards the 32.8% support (114.72/99.20 Fibonacci retracement level).

Resistance remains firm at the 50% Fibonacci level (107.00), while immediate support sits at the 105.20 level (38.2% retracement level).

DXY Daily Chart on XTB, prepared by Alison Heyerdahl

EUR/USD Daily Chart on XTB by Alison Heyerdahl

As expected, the EUR/USD moved decisively higher on the back of the Fed’s announcement, bouncing off the upward trendline from the end of September 2023. Sitting at the 23.6% Fibonacci retracement level of the July – October downward trend, for the bulls to remain in control, the price will have to drive the exchange rate above 1.0695, which could see a rally towards the 38.2% Fibonacci level of 1.0785.

Conversely, if the bears manage to push prices below 1.0535, we could see a move towards the 105.00 psychological handle, while further downside moves could see the October 2023 low come into sharp focus.