The Euro May Become a Problem for the ECB

The strengthening of the regional currency against the US dollar risks slowing down European inflation.

Too high and too fast. Markets already know that Donald Trump does not favor a strong dollar. However, as soon as the US president stated that the greenback's decline was significant, EUR/USD shot toward 1.21 in just moments. Markets shoot first and then analyze, which makes the dollar's decline below $1.20 appear logical. The reaction was indeed too exuberant.

From the perspective of purchasing power parity, the US dollar appears overvalued. Against major world currencies, with the possible exception of the Swiss franc, the euro and yen are particularly undervalued. It turns out Trump was not wrong to criticize Europe and Japan for deliberately weakening their currencies and engaging in unfair competition.

It should be noted that this criticism did not go unheeded. Since the Republican took office as president, the euro has risen by 16% against the US dollar. The process is ongoing, and the competitiveness of American companies is improving. However, is this good news for the United States?

The risks of a euro reversal have reached their highest point since 2020, with the futures market believing in an EUR/USD rally toward 1.25 within three months. However, Goldman Sachs warns that with a national debt of $39 trillion, a weakening dollar is a bad idea. Devaluation reduces the Treasury's ability to sell bonds to foreign holders. How else can one close the colossal budget gap? By raising taxes? It's unlikely that the authorities will pursue that path. Washington needs a stable currency, and for that, Donald Trump must not allow any rhetoric that welcomes its devaluation.

In Europe, the situation is different. The rhetoric from the Governing Council members indicates that a strong euro could become a problem. In this scenario, there is a risk of failing to meet the ECB's inflation forecasts due to lower import and consumer prices. According to the head of the Bank of France, the European Central Bank is closely monitoring developments in the foreign exchange market and will consider the strengthening of the euro as one of the factors in its interest rate decisions. Frankfurt may turn back to easing monetary policy while watching the EUR/USD rally.

In theory, this should weaken the "bulls'" positions in the main currency pair. However, we live in a world where the fundamental analysis's primary principles are seriously questioned. It was previously believed that a strong economy makes a currency strong. Now it is clear that even in a strong economy, the currency can still be weak.

Technically, on the daily chart, EUR/USD is experiencing a pullback to the upward trend. The bullish positions are solid; therefore, bounces from support levels such as pivot levels at 1.1955, 1.1830, and 1.1865 should be used to form long positions in the euro against the US dollar.