27.08.202600:38 Forex Analysis & Reviews: The Euro Stands at the Threshold

Prepare for uncertainty: the euro is in no hurry to leave its familiar territory. The EUR/USD pair has frozen in a narrow range, awaiting the meeting of central bank heads in Jackson Hole. Investors have decided to wait out the uncertainty.

This caution is not arbitrary. Central bankers around the world are likely to adopt a cautious stance and view inflation as a risk they would prefer not to take on. According to Thin Ice Macroeconomics, one never knows when the next supply shock will occur. The memory of the spike in energy prices following Russia's invasion of Ukraine is still fresh. Officials who underestimated that spike are now closely monitoring the Strait of Hormuz.

Isabel Schnabel will be part of the European Central Bank delegation at Jackson Hole, and her voice will be firm. The central bank has already raised rates by a quarter point in June and will repeat the maneuver in September. According to Schnabel, the conflict in the Middle East and the robust eurozone economy pose risks of accelerating inflation, and price growth is expected to exceed 2% for a "prolonged period" due to higher electricity prices. At the current interest rates, inflation is unlikely to return to the target. Therefore, further tightening of monetary policy will be necessary.

Dynamics of Gas and German Bond Yields

Meanwhile, the main threat has shifted from oil to gas—now a headache for bond traders. Gas prices have approached five-month highs, with winter contracts twice last year's rates, and the yield on 10-year German bonds has reached levels not seen in decades. Gas accounts for 21% of the EU's energy balance, meaning its price directly impacts inflation.

The effect on the euro is twofold: rising gas prices fuel inflation and increase the chances of further monetary policy tightening by the ECB. But at the same time, the ghost of 2022 looms, when the energy crisis drove the euro below parity with the dollar.

Dynamics of the Spread between French and German Bond Yields

Politics also adds to the mix. France enters the budget dispute season: the week that began with a cabinet meeting will end with a review by rating agencies. Macron's bill is considered the riskiest of his presidency—a prelude to the May elections, where successors intend to rewrite his rules. Fragmentation has already derailed the last two budgets; if the plan is not approved, the deficit risks growing until the voting rounds on April 18 and May 2. France is quite concerning for the EUR/USD.

Thus, the euro finds itself between two fires: the ECB's tightening is beneficial, but the energy and political backdrop works against it. Will the pair hold in the range after Jackson Hole?

Technically, on the daily chart, the EUR/USD shows short-term consolidation within the trading range of 1.1650 to 1.1685. A breakout strategy makes sense. A breakout above the upper boundary with a sustained close above it provides grounds for buying. A successful breach of the lower boundary signals a sell of the euro against the U.S. dollar.