EUR/USD: Fundamental Analysis and Potential Pullback

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At the start of the European session, the risk sentiment remains subdued as Asian equities trade with mixed results, failing to capitalize on the previous rally in Wall Street. The US Dollar, on the other hand, is consolidating its weekly gains near two-month highs, mirroring the lackluster performance of US Treasury yields across the yield curve.

Optimism surrounding a potential US debt ceiling deal was dampened by a Reuters report that highlighted concerns from a small but influential Republican faction. They warned that they could block any agreement to raise the $31.4 trillion debt ceiling in the House of Representatives unless the accord includes substantial federal spending cuts. Furthermore, fresh tensions between the US and China over Taiwan are keeping traders on edge. The US Trade Representative's office announced a partial agreement between the US and Taiwan on their "21st Century" trade initiative, covering customs, border procedures, regulatory practices, and small businesses. This development clouds the outlook for a scheduled visit to the US by a Chinese commerce official next week.

However, US stock futures are showing a 0.15% increase, as market participants maintain hope for a debt ceiling deal by Sunday when President Biden and House Minority Leader Kevin McCarthy resume talks.

Despite the overall risk-on sentiment in the market, the US Dollar has extended its upward trend for the past three days. This is mainly due to hawkish comments from US Federal Reserve (Fed) policymakers and increasing expectations of a 25 basis points (bps) interest rate hike in June. Market expectations for a June rate hike have risen to a 36% probability, compared to a mere 10% chance at the beginning of the week.

Dallas Fed President Lorie Logan stated that current data does not support skipping an interest rate hike in the upcoming June meeting. Fed Governor Philip Jefferson highlighted that inflation remains elevated, while St. Louis Fed President James Bullard advocated for higher interest rates, viewing them as insurance against inflationary pressures.

Looking ahead, market focus will be on updates regarding the US debt ceiling and speeches by central bank officials, as there are no major economic data releases scheduled on both sides of the Atlantic. The speech by Fed Chair Jerome Powell will receive particular attention, while end-of-the-week flows are expected to influence market dynamics.

EUR/USD is experiencing renewed buying interest, resuming its rebound towards the 1.0800 level in early European trading. This comes as the US Dollar corrects in tandem with the pullback in US Treasury bond yields. Eurostoxx futures are up 0.05% at the moment. According to sources cited by Bloomberg, the European Central Bank (ECB) is reportedly intensifying its scrutiny of bank liquidity and may consider raising liquidity requirements.

From a technical perspective, there is a possibility of a pullback today around the previous resistance level, particularly at the 38.2% and 50% Fibonacci retracement levels. Only in this scenario would we consider a new short setup.

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