EUR/USD: "Buy the rumor..."

[Ben Graham]

The euro-dollar pair, following almost two weeks of sideways movement, suddenly surged into the 1.18 figure, breaking out of the 1.1680–1.1760 price range, which corresponds to the middle and upper lines of the Bollinger Bands indicator on the daily chart. Riding this northern impulse, EUR/USD buyers pushed through the upper boundary of the price corridor and reached 1.1819, marking a new nearly three-month high. The last time the pair traded in the 1.18s was at the end of June, and before that, four years ago in September 2021. If the Federal Reserve does not adopt an overly cautious position on Wednesday, EUR/USD bulls could not only secure a foothold in the 1.18 area but also potentially test the resistance at 1.1870, which matches the upper Bollinger Band on the weekly chart.

Tuesday's price rally in EUR/USD is driven by two factors: first, the overall weakening of the US dollar, and second, relatively solid ZEW indices.

The US dollar index has been sliding for a second consecutive day, hitting a two-month low on Tuesday (96.58). "Dovish" expectations regarding the Fed's future actions are intensifying following a mixed string of reports on the US labor market. Ahead of the Fed's September meeting (outcome to be announced on Wednesday, September 17), an increasing number of analysts believe the central bank is lagging in cutting rates. Now, it is expected that the Fed will "catch up," easing monetary policy more aggressively.

This is a controversial view (given the overall CPI acceleration in August and the stagnation of the core index), but here it's all about market psychology. The behavioral factor among traders has worked in favor of EUR/USD buyers. Until Monday, traders were cautious, aware that excessive dovish expectations could backfire. But on Tuesday the market began to price in a "dovish cut" in advance: the famous "buy the rumor..." principle.

Now, market participants are not only convinced the Fed will cut rates by 25 basis points on Wednesday, but also that it will signal more to come. According to the CME FedWatch tool, the probability of an additional 25-point rate cut in October is almost 80%, with about a 70% chance of another cut in December.

Will the Fed "guarantee" this scenario for traders? It's not impossible, considering the rapid cooling of the US labor market. Still, we should remember the Fed usually tries to maintain balance in its rhetoric. Meanwhile, traders, judging by market expectations, are unlikely to tolerate any "ifs"—any sign of hesitation could be interpreted against the greenback.

In that case, the "buy the rumor, sell the fact" rule will be fully at play—both in "buy" and "sell" contexts.

In other words, the market is currently preemptively playing out an ultra-dovish scenario that may not come to pass (and most likely won't). If the Fed disappoints on Wednesday, the spring could snap back in the other direction. That's why long positions in EUR/USD should be approached with caution, despite the confident price growth. The pair is rallying on shaky ground, pricing in an event that hasn't happened yet.

Additional support for EUR/USD buyers on Tuesday came from the ZEW indices, though these are not without caveats. According to the report, the German economic sentiment index rose in September to 37.3 (from 34.7), exceeding the consensus forecast for a decline to 27.3. A similar situation occurred with the eurozone-wide index, which ticked up slightly (to 26.1 from 25.1), beating the 20.3 consensus.

However, the ZEW current conditions index disappointed: it fell to -76.4, below the expected -75.0, marking a second consecutive month of declines.

In other words, the ZEW indices reflected growing pessimism about current conditions against a moderately improving outlook for the next six months. The result was interpreted in the euro's favor, so the pair is rising not only on dollar weakness, but also thanks to strengthening in the European currency.

Still, in my view, it makes sense to take a wait-and-see position on the pair. While there's a non-zero chance of an ultra-dovish scenario from the Fed, there's also a high risk the central bank will deliver a "hawkish cut." That is, the Fed might cut rates but accompany it with very cautious rhetoric about further easing this year. Such a result from the September meeting would put pressure on EUR/USD, given the market's already feverish dovish expectations.

The material has been provided by InstaForex Company - www.instaforex.com