• Investors see rate cuts by the ECB, despite post-meeting hawkish rhetoric

• Eurozone prel. PMIs the next piece of information that could shake those bets

• Euro could slide if the PMIs disappoint when released on Friday, at 08:00 GMT

After ECB meeting, the market sees rate cuts for next year

Last week, the ECB decided to raise interest rates by 25bps, taking the deposit facility rate to a record high of 4%. However, with the latest data pointing to a severely wounded economy, officials cut their economic growth forecasts, and despite raising those for inflation, they hinted that this could be the last rate increase in this tightening cycle.

The euro tumbled and market participants began pricing a series of rate reductions for next year, allowing only a small probability for another hike by December. Even after several policymakers, including President Lagarde, pushed back on rate cut bets the following days, and noted that further increases cannot be ruled out, investors were not convinced. They are still assigning only a nearly 30% probability for another quarter-point increment and they are seeing rates being 60bps below current levels by the end of next year.

Attention now falls on Friday’s preliminary PMIs

This suggests that market participants are placing more trust in economic data than just remarks, and that they are more concerned about economic performance than high inflation. With that in mind, Friday’s preliminary PMIs for September may attract special attention. The manufacturing PMI is forecast to have slightly increased but to remain well below the boom-or-bust zone of 50 that separates expansion from contraction. What’s more, both the services and composite indices are expected to have slid further into the contractionary territory, ringing the recession alarm bells even louder.

Should this be the case, the euro is likely to come under renewed selling pressure, even if the price subindices point to some acceleration due to the latest rally in oil prices. For traders to start buying euros again, upcoming data may need to start pointing to some economic recovery, or at least a stabilization, something for which there is no evidence yet.

US and Eurozone growth dynamics drive euro/dollar

In contrast to the Eurozone data, US economic indicators have been pointing to a resilient economy, not justifying expectations of around 80bps worth of rate reductions by the Fed for 2024. Taking that into consideration, the risks surrounding the US dollar from the outcome of the FOMC decision on Wednesday may be tilted to the upside, as there may be a decent chance for the new dot plot to point to a higher rate path than the one currently implied by the market.

Ergo, a hawkish Fed combined with further softness in the Eurozone PMIs may be a toxic cocktail for euro/dollar. The pair has been in a recovery mode due to the relatively hawkish comments by several ECB policymakers after last Thursday’s decision, but that recovery may stay limited and short-lived below the 1.0765 resistance level, marked by the highs of September 12 and 13. Another round of declines would likely take the price back below the key territory of 1.0665 and perhaps confirm a bearish trend reversal on the daily chart. The next important support may be the 1.0530 zone, which stopped the pair from moving lower back in February and March.

For the outlook of euro/dollar to brighten again, the bulls must sweat a lot. They may have to drive the action all the way above the 1.1070 territory, which provided strong resistance on several occasions this year.