The euro climbed against the US dollar for a third consecutive session on Monday, touching a two-month peak of 1.1596, as disappointing US economic data fueled expectations that the Federal Reserve will pause its tightening cycle. The single currency is now testing the key 1.1600 level.
A sharp drop in US retail sales, combined with recent cooling in inflation, has driven the market's implied probability of a September Fed rate hike down to 33%. This has placed persistent downward pressure on the greenback, while the euro has been supported by the market's full pricing of a quarter-point rate increase from the European Central Bank in September.
Investors are now looking ahead to the release of the Federal Open Market Committee (FOMC) meeting minutes on Thursday, seeking fresh clues about the Fed's future policy direction.
US Retail Sales Miss, Dollar Under Sustained Pressure
The US Census Bureau reported on Friday that retail sales fell 0.6% month-over-month in July, the largest monthly decline since last May, following a 0.2% increase in June. The figure was far below the market consensus for a 0.1% rise. On an annual basis, retail sales growth slowed to 5.0% from 6.8% in the prior month.
This weak data, arriving after softer CPI and PPI readings, reinforces the view that consumer spending is losing momentum. The CME FedWatch Tool now shows the implied probability of a September rate hike has dropped to 33%. The US Dollar Index is hovering near a two-month low, providing a sustained tailwind for the euro.
Steepening Yield Curve Adds to Dollar's Headwinds
Strategists at Scotiabank note that the yield spread between 2-year and 30-year US Treasuries has widened to 108 basis points, a sign of significant curve steepening. This development reflects both a repricing of the Fed's policy path and growing concerns about US fiscal sustainability.
While short-term yields have remained relatively stable due to policy expectations, long-term yields have risen on worries about increased Treasury supply, a widening deficit, and sticky inflation. Scotiabank highlights that a steeper yield curve is generally a negative for the dollar. In the current environment, the rise in long-term yields is being interpreted more as a signal of fiscal weakness and long-term inflation concerns rather than optimism about growth or a tightening of policy.
The market sees this as a potential discount on US credit and fiscal discipline, undermining the greenback's safe-haven and yield advantages. This dynamic supports Scotiabank's view that the dollar index is at risk of falling toward the mid-98 region. The inability of higher long-term yields to support the dollar, combined with the steepening curve, is releasing doubts about the US macro backdrop and weighing on the dollar index. If fiscal and policy uncertainties persist, the dollar could remain under pressure.
ECB Rate Expectations and Geopolitical Risk Provide Euro Support
For the euro, the market has largely priced in a 25-basis-point rate hike from the European Central Bank in September, with inflation still well above the 2% target providing policy support. Additionally, the ongoing standoff between the US and Iran, with no prospect of reopening the Strait of Hormuz, is keeping geopolitical risk premiums elevated.
Furthermore, inflation concerns stemming from oil price volatility may cause traders to be cautious about betting on further dollar weakness, which could limit the euro's short-term upside against the greenback.
Summary
In summary, the euro has risen for three consecutive days to a two-month high, driven primarily by broad-based weakness in US economic data. A surprise decline in retail sales, combined with cooling inflation, has pushed the probability of a September Fed rate hike to 31%, keeping the dollar under pressure. The euro is also benefiting from expectations of a September ECB rate hike and geopolitical risk premiums. The market's focus is now on the FOMC minutes due Thursday, as any clues about the Fed's policy path could trigger volatility. While the euro's short-term bullish bias remains intact, the risk of chasing prices above the 1.1600 level is increasing. A pullback to the 1.1520-1.1580 zone could attract buying interest.
At 14:58 Beijing time on August 17, EUR/USD was trading at 1.1595/96.
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