EUR/USD has been on an impressive rally since the Federal Reserve’s last meeting at the end of July, hovering near recent highs above the 1.1200 level. However, these gains could be at risk if the U.S. central bank falls short of market expectations following this week’s FOMC meeting, which concludes on Wednesday. Investors have been betting on a 50bps rate cut, fueled by Fed Chair Jerome Powell’s remarks at the Jackson Hole symposium, where he emphasized that the Fed is not keen on seeing further weakness in the U.S. labor market. Since then, labor market data has indicated signs of softening, leading to increased speculation that the Fed might opt for a more aggressive cut.
Much of EUR/USD’s 4.0% rally off its August lows can be attributed to these dovish expectations. However, mixed economic data, including strong August retail sales and industrial output, complicates the picture and could provide a case for a more modest 25bps cut. Currently, rates markets are pricing in about a 65% chance of a 50bps cut, leaving room for disappointment if the Fed delivers a smaller cut and a less dovish tone than investors are hoping for.
A more cautious Fed, opting for only a 25bps reduction and signaling limited future cuts, could send U.S. Treasury yields higher and boost the dollar. In such a scenario, the German-U.S. yield spreads would widen, dragging EUR/USD lower. This would likely negate the bullish technical signals that have been driving the pair’s recent upward momentum, erasing much of the August rally. The bullish narrative around EUR/USD could quickly shift to a bearish one if Powell’s comments fail to align with market expectations for an aggressive easing cycle.
Technically, EUR/USD bulls have been in control, but recent price action hints at some caution ahead of the Fed’s decision. The pair opened in New York around 1.1135 after hitting a 10-session high of 1.1146 overnight. However, the positive sentiment faded as U.S. retail sales and industrial output figures supported a stronger dollar, driving the pair down to 1.1112 by the end of the session. While tighter German-U.S. yield spreads and EUR/JPY gains helped limit the downside, technical indicators are turning mixed. The daily RSI has diverged, and a daily inverted hammer pattern has formed, signaling potential indecision in the market.
Still, the broader outlook remains cautiously optimistic, with the monthly RSI rising and the pair trading above key daily moving averages. Investors will now closely focus on the Fed’s rate decision and Powell’s press conference, where any hawkish surprises could send EUR/USD sharply lower. If the Fed’s messaging is less dovish than anticipated, the euro may give back much of its recent gains, with a quick move back below 1.1100 likely in such a scenario.
