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The disappointing reports on the US that came out one after another last week contributed to the weakening of the US currency, which pushed the USD index to monthly lows around 91.95 points and became a tailwind for the EUR/USD pair.
It also received support from the hawks of the European Central Bank Governing Council, who expressed concern about excessive monetary stimulus after another increase in inflation in the eurozone.
These comments served as fertile ground for speculation that the ECB may announce a reduction in the pace of its emergency bond purchases already at the September meeting, thereby outstripping its US counterpart, who took a wait-and-see position.
Armed with this idea, the bulls were able to push the EUR/USD pair above 1.1900.
The weak US jobs figures published at the end of last week should have confirmed the downward trend of the dollar that has emerged over the past couple of weeks, since in this case the Federal Reserve could continue to sit idly by.
However, nothing of the kind happened.
Contrary to expectations, the greenback was able to get up from its knees and reverse its recent losses, while the single currency already went on a downward path towards the $1.18 mark, being among the main victims of the increased demand for USD.
The chances that the Fed will announce a reduction in QE at the September meeting have decreased after the publication on Friday of the August NFP report, which showed that the US economy created the minimum number of jobs in seven months.
However, investors seem to remain convinced that the US central bank will begin to wind down monetary stimulus in December and will probably complete this process by mid-2022.
Expectations of the Fed's imminent announcement of a reduction in QE raised the yield of 10-year treasuries above 1.38% and supported the dollar.
Over the past week, the USD index has already gone up by 0.2%.
Having recovered on Friday from monthly lows, on Monday and Tuesday the greenback continued to push its main competitors, forcing them to return to the levels that were observed before the publication of the US employment report for August.
According to strategists at Mizuho Bank, the strengthening of the dollar this week seems to be the result of a shift in investors ' focus on wage growth in the US in August, which indicates a possible increase in inflationary pressure in the country and suggests that the Fed will stick to its plan to reduce QE.
The head of the St. Louis Fed, James Bullard, believes that the US central bank should continue to implement a plan to reduce its large-scale pandemic stimulus program, despite the slowdown in US job growth last month.
In addition, the spread of the COVID-19 "delta" strain in the world continues to cloud the prospects for the global economy, which supports the demand for the dollar as a safe haven asset.
"The risk avoidance in the air, along with the growth of US bond yields, helped the dollar to continue the recovery that began after the release of August US employment data," National Australia Bank analysts said.
On Wednesday, the USD index rose above 92.85 points, showing growth for the third consecutive session.
In the event of an increase in the upward momentum and a breakthrough of the round mark of 93.00, the dollar bulls may aim for the peak levels of the end of August in the area of 93.10, and then at the annual highs in the area of 93.70.
Meanwhile, the EUR/USD pair remains under pressure, aiming for 1.1800 against the background of the continued strengthening of the dollar.
The recent improvement in the estimate for eurozone GDP growth in the second quarter contrasts with the September data on business sentiment in the currency bloc from ZEW and joins the mixed tone of ECB policymakers to confuse EUR/USD traders ahead of this week's key event.
Bostjan Vasle, a member of the ECB's Governing Council, said today that an adaptive monetary policy is still needed to counteract the consequences of potential new waves of the pandemic.
At the same time, another ECB representative, Robert Holzman, said that the central bank may tighten policy earlier than many now expect, since inflationary pressure in the eurozone may be more stable.
The next meeting of the ECB will be held on Thursday, which will be important, since it is likely that a reduction in the special asset purchase program of PEPP can be announced, analysts at Aberdeen Standard Investments note.
"A fairly clear statement on this matter and a corresponding reading between the lines of the new inflation forecasts can significantly increase the euro exchange rate, even if ECB President Christine Lagarde tries to soften the blow at a press conference," Saxo Bank strategists believe.
The recent surge in inflation in the eurozone to a 10-year high of 3% has caused hawkish rhetoric from a number of ECB politicians.
"In the foreign exchange market, such events were the first kind of push to the euro after a long period when the EUR/USD pair as a whole was a mirror of the dynamics of the dollar. In order to continue to benefit from a softer dollar environment, the euro will probably need to receive some hints from the ECB this week that discussions on tapering asset purchases are continuing. At the same time, the central bank may not meet the hawkish expectations of the market," ING analysts said.
"The EUR/USD pair has the opportunity to abandon some recent achievements if our expectations regarding the ECB's still very cautious position – which should also be reflected in the generally unchanged inflation forecasts for 2022 and 2023 - turn out to be correct," they added.
The bears continue to dictate the rules regarding the European currency in the first half of the week, forcing the EUR/USD pair to back away.
It remains in a defensive position and is approaching the key support in the area of 1.1800.
A breakthrough below will open the way for the bears to 1.1780 (20-day moving average). Further down, there are no significant support levels up to annual lows around 1.1660.
It is assumed that the pair will maintain a negative attitude while trading below the 200-day moving average, which is now passing near 1.1999.
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