The euro surged to nearly a five-week peak of $1.0826, marking its strongest performance in over a week, as demand for the dollar eased despite uncertainties surrounding US PPI data, deepening speculation on the Fed's rate cut trajectory. European stock indices remained steady, with investors awaiting the April US CPI figures for further guidance.
Internally, the latest ZEW survey revealed encouraging signs, suggesting that the worst of the economic downturn in the region may be over. Germany's ZEW investor sentiment index soared to 47.1 in May, supported by rising real incomes, improved domestic consumption, and recovering export demand. While this marks the gauge's tenth consecutive monthly increase and its highest level since February 2022, the current component of the ZEW remains subdued, underscoring lingering growth risks as the industrial sector struggles to rebound. Expectations of a June ECB rate cut continue to drive optimism, with ECB's Knot reiterating the possibility of monetary easing at the upcoming meeting, echoing sentiments expressed by Fed's Powell at the Annual FBA meeting.
EUR/USD breached its 200-day SMA following the release of higher-than-expected US PPI data, injecting much-needed volatility into the market. The pair is now eyeing its 100-day SMA around $1.0826, with overnight option implied volatility reaching a 14-month high of 12.85%. A further uptick in volatility could propel euro bulls towards $1.0900, signaling a break from the bearish trend observed since March. Investors are adjusting their positions in anticipation of a stronger euro, reflected in the most bullish 1-week EUR/USD risk reversals since February, as expectations of softer US inflation align monetary policy outlooks on both sides of the Atlantic. Hedge funds have significantly reduced their short positions on the euro by approximately 40% over the past month, according to the latest CFTC data. As of now, the implied probability of an ECB rate cut next month remains steady at around 95%, with markets pricing in 68 basis points of cuts by year-end, compared to the Fed's projection of 54 basis points.
