EUR/USD continues to hold up well in mid-1.0500s despite risk-off conditions with focus on US CPI

• EUR/USD is holding up fairly well despite risk-off conditions and weak EZ data in the mid-1.0500s.
• The main risk event of the week will be Wednesday’s US CPI.
• Fed/ECB policy divergence should keep the pair a sell on rallies, for now, many strategists think.

EUR/USD has held up surprisingly well on Monday in the face of further sharp downside in the global equity space that would typically lend support to the safe-haven US dollar plus soft Eurozone Sentix survey data for May. The pair is for now moving sideways in the mid-1.0500s, having found support earlier in the session following a brief dip under the 1.0500 mark.

Traders are citing concerns about central bank tightening, which is also reflected in further upside in US, European and global yields on Monday, as one factor weighing on risk appetite at the start of the week. Meanwhile, the familiar themes of slowing global growth amid continued global supply chain difficulties plus the disruptive impact of the Russo-Ukraine war and Chinese lockdowns are all also being cited as weighing on sentiment.

Should risk assets continue to trade on the ropes this week, then that would suggest further EUR/USD downside. The key event of the week will be US Consumer Price Inflation data out on Friday, which is expected to show the YoY pace of headline price growth easing to 8.1% in April from 8.5% in March.

Whilst this will come as a welcome decline that could give EUR/USD a short-term lift, with the headline rate of CPI still so high above the Fed’s 2.0% target, no dovish Fed policy shift is expected any time soon. Last week’s policy announcement and subsequent rhetoric suggest the Fed remains intent on getting interest rates back to neutral (around 2.5%) by the end of the year and then probably substantially above in 2023, as the bank seeks to cool demand and ease inflation.

The ECB, meanwhile, though expected to take interest rates back to positive later this year (also a big hawkish shift versus the bank’s policy stance just a few months ago), isn't expected to tighten monetary policy anywhere near as fast. Many traders may continue to view EUR/USD as a “sell on rallies” for now, with resistance in the form of the 2020 lows in the 1.0630 area likely to prove formidable.

In the longer term, a drop in EUR/USD to 2016 lows in the mid-1.0300s still seems likely. Many banks have been calling for the pair to fall back to parity by the end of the year if US inflation doesn’t ease as much as the Fed hopes, forcing them to signal an intent to raise interest rates well above neutral (say to 4.0% or higher) by the end of 2023.