Weekly Fundamental Euro Forecast: September ECB Hike Odds Stay Elevated

A REVIEW OF EUROPE WEEK

The Euro gained ground versus six of its seven main peers during a generally favorable week. The EUR/JPY rate had the best performance, rising by +0.87 percent after suffering significant losses earlier in the week. The euro saw gains against the three currencies that make up commodities:

EUR/AUD rates rose by 0.68 percent, EUR/CAD rates rose by 0.63 percent, and EUR/NZD rates moved up by 0.29 percent. Rates for EUR/CHF also increased by 0.68 percent, marking their first increases after falling for seven straight weeks. Following the release of the July US employment data, EUR/USD rates were the lone decliner, falling by -0.45 percent.

QUIET EUROZONE ECONOMIC CALENDAR

The economic calendar for the Eurozone is considerably calmer than in recent weeks during the second week of August. Only one "high" rated data release is scheduled for the next days, while there are less than ten "medium" rated releases. The summer's "dog days" have arrived.

The following are the significant events on the Eurozone economic calendar for the next week:

The final July German inflation rate (HICP) data will be made public at 6 GMT on Wednesday, August 10. At 8 GMT, the final Italian inflation rate (HICP) data for July is expected.

The French IEA oil market report will be released at 8 GMT on Thursday, August 11.

The final French inflation rate (HICP) report will be announced at 6:45 GMT on Friday, August 12, while the 2Q'22 French unemployment rate will be released at 5:30 GMT. At 7 GMT, the last Spanish July inflation rate (HICP) announcement is expected. At 8 GMT, the June Italian trade balance data will be released. At 9 GMT, the June industrial output data for the Eurozone will be released.

EXPECTATIONS FOR ECB RATE HIKES EVOLVE

The European Central Bank has maintained a stance that implies the difference between the main interest rates of the ECB and other significant central banks will continue to close after underperforming for most of 2021 and 2022.

Rates markets are discounting a 100% likelihood of a 25 bps rate rise in September and an 88 percent possibility of a 50% rate hike, which would raise the ECB's main rate to 0.50 percent, after the central bank delivered a 50 bps rate hike in July, the greatest increase of this kind since 2000. The ECB's key rate is expected to increase to 1.13 percent by the end of 2022, according to rate markets. The ECB is still trying to strike a compromise between worries over multi-decade high inflation, slowing economy, and a revived Eurozone debt crisis.

10-YEAR YIELDS FOR FRENCH, GERMAN, GREEK, ITALIAN, PORTUGUESE, AND SPANISH (AUGUST 2020 TO AUGUST 2022) (CHART 1)

As of now, the ECB's efforts to stop bond market fragmentation, or the expansion of yield gaps as during the 2010s Eurozone debt crisis, are succeeding. The Transmission Protection Instrument (TPI), an anti-fragmentation instrument that allows the ECB to sell part of its core debt holdings and use the profits to buy peripheral debt, only seems to have been implemented lately. If the Euro is to have any chance of launching a more major rise over the coming months, the ECB's attempts to stop yield spreads from expanding must continue to be successful.

Positioning for CFTC COT Euro Futures (August 2020 to August 2022) (CHART 2)

Regarding positioning, the CFTC's COT for the week ending August 2 shows that traders reduced their net-short holdings in the euro from 41,875 to 37,541 contracts. The eight-week stretch of net-short positioning for the euro is the longest since March 2020. There is still a chance for a rally to cover short positions.