EUR/USD: Euro Looks Worried Ahead of the ECB Rate Decision. Will It Fall?

Stock markets sail higher, but the U.S. dollar holds its ground. Will it push higher against the euro as the European Central Bank begins cutting interest rates?

• Wall Street erupts in cheers as U.S. ISM data delivers “goldilocks” results.
• Eurozone stocks are at risk if the ECB meeting delivers a “hawkish cut.”
• The euro may drop vs. the U.S. dollar if the ECB opts for a dovish surprise.

Stock markets roared with delight even as the May edition of the service sector activity survey from the Institute of Supply Management (ISM) sailed past consensus forecasts (as anticipated). The headline index jumped to 53.8, speaking to the fastest pace of expansion since August 2023. Economists penciled in 50.8 ahead of the release.

The strong result might have meant trouble for stock markets if its portrayal of a strengthening economy extended to bets on stickier inflation and cooled Federal Reserve interest rate cut expectations. However, the internals of the report seemed to put such fears to bed, at least for now.

Stock markets get a “goldilocks” lead from U.S. ISM data

The subindex tracking business activity surged to the highest since November 2022 while new orders expanded at the fastest in two months. Nevertheless, the gauge tracking price growth cooled and employment in the sector continued to contract, albeit at a slower pace. All this seemed to present robust growth without added inflationary fears.

Tellingly, the policy path implied in fed funds futures was left little changed. The markets are still pricing in 38 basis points (bps) in easing for 2024 and 68bps-worth of cuts in 2025. That amounts to at least one standard-sized 25bps cut this year and two of them next year. This much was already in the market ahead of the ISM release.

The spotlight now turns to a monetary policy announcement from the European Central Bank (ECB), which is widely expected to begin cutting interest rates. Futures markets have fully priced in a 25-bps reduction at this month’s meeting of the policy-steering Governing Council.

Euro looks worried as the ECB readies a “hawkish cut”

With the move itself widely expected, traders are likely to focus on the tone and guidance presented at the press conference with ECB President Christine Lagarde following the policy announcement.

Leading purchasing managers index (PMI) data from S&P Global shows the currency bloc recovering from last year’s brief recession. It put the pace of economic activity growth at an 11-month high in May. That has helped nudge up inflation, which unexpectedly rose to a three-month high of 2.6% year-on-year last month.

The markets might reckon that this sets the stage for a somewhat feisty tone from Ms. Lagarde, where she tries to keep inflation expectations anchored by playing down scope for stimulus even as the central bank begins to deliver it. Much might be priced in already, so an unexpectedly dovish outturn may be most impactful for the markets.

The euro might slip lower against the U.S. dollar in such a scenario. The single currency has slipped lower over the past two trading sessions even as U.S. Treasury yields moved lower, warning of vulnerability. Eurozone stock markets (ETF: EZU) might be ground zero for weakness if a “hawkish cut” does materialize, however.

Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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