EUR/USD Hits Six-Week Low Amid Political Risk and Fed Doubts

The EUR/USD pair dropped to its lowest point in six weeks due to increased euro selling, driven by perceived greater political risk in Europe and doubts about the Federal Reserve's willingness to cut rates before late in the year. The recent strong May payrolls report further solidified these doubts. Speculative buyers have been left underwater, adding to the downward pressure on the euro. The market is now focused on the upcoming U.S. CPI release and the conclusion of the Fed meeting, which are crucial for determining the near-term direction of the euro and the dollar. The dollar index fell 0.14%, led by a 0.24% drop in EUR/USD, which hit a low of 1.07195, piercing key support levels. A close below these levels, especially after Wednesday's U.S. inflation and Fed policy updates, would be bearish. Holding these supports is crucial, as recent speculative long positions have been pushed back into the market at higher prices. If the CPI meets or exceeds forecasts and Fed projections keep rate cut expectations low, EUR/USD could remain under pressure.

USD/JPY Rises Slightly Amid Treasury Yield Movements

USD/JPY rose 0.1%, recovering from an early pullback as Treasury yields came off their lows but weakened again late in the day. The pair's recovery from May's intervention-led lows may need further support from Wednesday's U.S. events to push past the May high of 157.99. Beyond the U.S. events, Friday's BoJ meeting will be crucial for indications on tapering JGB purchases. A hawkish outcome from the U.S. CPI and Fed meeting could boost USD/JPY to test higher levels.

Sterling Flat Amid Mixed UK Labor Data and Yield Spreads

Sterling remained flat after briefly slipping with gilts-Treasury yield spreads, following mixed UK labor data. The pair slipped from its 1.27495 highs in sympathy with risk-off flows and a modest bounce in EUR/GBP. However, prices held the uptrend line from April and May lows for the second consecutive day. The upcoming U.S. CPI and Fed meeting will be critical in determining whether the similar rate cut expectations between the BoE and Fed will diverge, potentially reviving the uptrend or triggering a broader slide toward the 100-DMA and kijun at 1.2639/35.

Market Sentiment Hinges on Upcoming U.S. Inflation Data and Fed Policy Signals

In summary, the dollar index rose modestly ahead of the U.S. CPI and Fed meeting, with movements in EUR/USD and USD/JPY reflecting market anticipation. EUR/USD remains under pressure from political risks in Europe and doubts about Fed rate cuts. USD/JPY could gain further if U.S. data supports a hawkish Fed stance. Sterling's direction hinges on the divergence of BoE and Fed rate expectations following the U.S. CPI release. The overall market sentiment will be significantly shaped by the upcoming U.S. inflation data and Fed policy signals.

Risk-On Sentiment

Potential for Dovish Fed Outcomes:

• If the U.S. CPI data is below expectations or Fed projections hint at potential rate cuts earlier than anticipated, it could bolster risk-on sentiment.
• A dovish stance from the Fed could lead to a weaker dollar, making riskier assets more attractive.

Positive Data from Europe or Other Major Economies:

• Any positive economic data or resolution of political uncertainties in Europe could alleviate some of the pressure on the euro, supporting a risk-on environment.
• Improved economic indicators globally would encourage investment in higher-yielding assets.

BoJ Indications of Continued Support:

• If the Bank of Japan continues its accommodative policies and signals ongoing support for the economy, it could enhance risk-on sentiment, particularly benefiting equity markets and higher-yielding currencies like the yen.

Risk-Off Sentiment

Increased Political Risk in Europe:

• Heightened political instability or negative developments in Europe can lead to a flight to safety, with investors seeking refuge in safer assets like the U.S. dollar and gold.
• The euro is likely to remain under pressure, contributing to a broader risk-off sentiment.

Strong U.S. Economic Data and Hawkish Fed:

• A robust U.S. CPI report and hawkish signals from the Fed, including higher economic projections and limited rate cut expectations, would reinforce a risk-off sentiment.
• Higher Treasury yields and a stronger dollar would likely result, diverting investment away from riskier assets.

Global Economic Uncertainties:

• Continued uncertainties around global economic growth, trade tensions, or geopolitical conflicts can sustain a risk-off environment.
• Investors would favor safe-haven assets, such as the U.S. dollar, Japanese yen, and government bonds, over equities and emerging market currencies.

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