EUR/USD Near 1.156 as Weak US Jobs Put Fed Hike Bets Under Pressure

EUR/USD reached around $1.1558 on 10 August, leaving the euro close to its strongest level since mid-June. The dollar index was near 99.6, around its lowest level since 2 June, while the US 10-year Treasury yield had fallen to roughly 4.64%.

The immediate explanation appears obvious.

The United States unexpectedly lost 23,000 nonfarm jobs in July. Economists had expected an increase of around 80,000. June payroll growth was revised down from 57,000 to only 20,000, while May was revised from 129,000 to 63,000. The two previous months therefore contained 103,000 fewer jobs than previously reported.

Markets reacted by reducing the probability of another Federal Reserve rate increase in September. Futures pricing put the chance at around 44% on Monday, down from 67% a week earlier.

That combination has weakened the dollar and brought EUR/USD back towards 1.16.

But the pair has not yet broken convincingly through that area.

The reason is that the jobs report changed one half of the Fed debate without resolving the other.

The US labour market has become much harder to describe as strong.

US inflation is still too high to describe monetary policy as ready to turn dovish.

The real surprise was not only the July job loss

A negative payroll number naturally attracted most of the attention.

The revisions were arguably more important.

May and June payrolls were lowered by a combined 103,000 jobs. After the revisions, July’s decline followed growth of only 20,000 in June and 63,000 in May. Over the prior 12 months, payroll employment had increased by an average of only 34,000 per month.

That changes the interpretation of the labour market.

A single weak July figure can sometimes be dismissed as seasonal noise. July payroll data have produced unusually soft readings in previous years, and BLS itself described overall payroll employment as having changed little during the month.

Three months of weak or downwardly revised hiring are more difficult to ignore.

The market is no longer looking only at whether the US economy created jobs in July.

It is questioning whether the level of labour demand had already been overstated before July arrived.

That is a much larger issue for the Fed.

The falling unemployment rate does not cancel the weak payroll signal

At first glance, one detail appears inconsistent with the bearish employment story.

The unemployment rate fell from 4.2% to 4.1%.

Normally, falling unemployment would strengthen the argument that the labour market remains tight.

The underlying household data are less reassuring.

The labour-force participation rate remained at 61.4% in July, but it has fallen by 0.7 percentage point since January. The employment-to-population ratio has declined by 0.5 percentage point over the same period.

A lower unemployment rate therefore does not necessarily mean more people found work.

Some of the apparent improvement comes from fewer people participating in the labour force.

Employment in the household survey fell by 87,000 in July, while the number of people outside the labour force increased.

For the Fed, that makes the 4.1% headline less comforting than it initially appears.

The unemployment rate is still low.

But the labour market beneath it is losing momentum.

There is still no clear recession signal

This is also why the dollar has weakened rather than collapsed.

The July report was poor, but it did not show widespread employment destruction.

Health care still added 22,000 jobs. Permanent job losers were little changed at around 1.7 million. People working part time for economic reasons were also broadly unchanged.

Average hourly earnings increased 3.2% from a year earlier, and the average private-sector workweek remained at 34.3 hours.

The labour market therefore appears to be cooling through slower hiring rather than a sudden wave of layoffs.

That distinction matters enormously for EUR/USD.

A collapsing US labour market would probably force markets to remove most remaining Fed tightening expectations and begin discussing eventual easing.

A slow-hiring economy gives the Fed more time.

It makes another rate increase harder to justify, but it does not automatically force the central bank in the opposite direction.

The dollar has lost one source of support.

It has not yet acquired a full easing cycle against it.

The jobs report changed the Fed debate from “how soon?” to “is another hike still necessary?”

Before Friday, markets were still seriously debating another increase in September.

The Fed had kept its target range at 3.50%–3.75% in July, but three policymakers voted for an immediate 25-basis-point increase.

The weak jobs report changed the burden of proof.

Another Fed increase now needs to be justified against a labour market that lost jobs in July and generated much less employment during May and June than previously believed.

Fed policymakers can still argue that inflation requires another move.

But they can no longer treat the employment side of the dual mandate as almost irrelevant.

That is why September hike pricing fell sharply after the report and remained around 44% on Monday.

For EUR/USD, this is an important shift.

The dollar is no longer supported by the assumption that higher Fed rates are the obvious next step.

From here, the Fed needs inflation data to rebuild that case.

Wednesday’s CPI report now has unusual power

The July US CPI report is scheduled for 12 August at 8:30 a.m. Eastern Time.

Reuters’ consensus estimate expects core CPI to rise 0.2% from June and 2.5% from a year earlier, compared with 2.6% annual core inflation in June.

Normally, a modest slowdown in core inflation would simply be interpreted as encouraging progress.

This report carries more weight because it arrives immediately after a major labour-market disappointment.

The market is effectively asking whether the Fed is facing:

weakening employment and moderating inflation,

or weakening employment but still persistent inflation.

Those two combinations produce very different EUR/USD outcomes.

If inflation continues cooling, the rationale for another Fed increase becomes substantially weaker.

If inflation surprises higher, the Fed’s problem becomes more difficult rather than easier.

The central bank would then be balancing a softer labour market against an inflation problem that still refuses to disappear.

June inflation explains why traders are not abandoning the dollar completely

The previous US inflation readings are the reason markets have not moved directly from “September hike” to “Fed easing.”

June headline CPI was still 3.5% year on year, while core CPI stood at 2.6%. Energy prices were 15.7% higher than a year earlier despite falling sharply during June itself.

The Fed’s preferred PCE measure looked even less comfortable.

June PCE inflation was 3.7% from a year earlier, while core PCE inflation was 3.3%. Real consumer spending still increased 0.4% during the month.

Those figures do not describe an economy where inflation has already returned close enough to 2% for monetary policy to ignore the price side of the mandate.

This is the main reason EUR/USD has moved towards 1.16 rather than exploding through it.

Weak employment has reduced the expected return advantage of the dollar.

Persistent inflation is preventing that advantage from disappearing altogether.

This euro rally is not entirely a dollar story

There is another difference between the current EUR/USD move and some earlier dollar sell-offs.

The euro now has more domestic support than it did several weeks ago.

Euro-area GDP increased 0.4% quarter on quarter in the second quarter, after being unchanged in the first quarter. Compared with a year earlier, GDP was 1.0% higher. Germany expanded 0.2%, France and Italy also grew 0.2%, while Spain recorded 0.7% quarterly growth.

The result matters because the euro had previously been held back by the assumption that another ECB increase would impose additional pressure on an economy already close to stagnation.

The second-quarter data do not eliminate that concern.

They show the economy has been more resilient than feared.

That gives the ECB more room to keep policy restrictive if inflation remains above target.

July business activity made the eurozone rebound look less temporary

Survey data for July reinforced that message.

The euro-area composite PMI increased to 52.0 from 50.0 in June, its highest level in eight months and the first reading clearly in expansion territory since March.

The services PMI rose to 51.7 from 49.4, while new orders increased at their fastest pace since November. Employment stabilised after six consecutive months of decline.

This is important for EUR/USD because the euro does not need spectacular European growth to benefit from weaker US data.

It only needs the eurozone to avoid deteriorating at the same time.

That is close to the current situation.

The US labour story has weakened.

The euro-area activity story has modestly improved.

The relative change is favourable to EUR/USD even though the United States still has the higher absolute policy rate.

Germany is providing slightly better evidence as well

Germany remains one of the biggest questions surrounding any sustained euro recovery.

Recent data have become less negative.

German industrial production increased 0.2% in June, marking a third consecutive monthly rise. Exports increased 0.9%, substantially above expectations, and reached a record €139.3 billion.

The details are not uniformly strong.

Imports surged 4.4%, narrowing the trade surplus to €15.4 billion. Exports to the United States fell 14.2%, and economists continue to warn that Germany’s industrial sector faces structural problems rather than only a temporary downturn.

That is why the eurozone story should not be described as a powerful new boom.

It is better described as less weak than previously feared.

For EUR/USD, that is currently enough to matter because the US side has simultaneously become less convincing.

Eurozone inflation has also moved in the euro’s favour

Euro-area annual inflation increased to an estimated 2.9% in July from 2.8% in June.

Energy inflation accelerated to 10.0%, services inflation increased to 3.3%, and inflation excluding energy, food, alcohol and tobacco stood at 2.5%.

This creates a very different ECB problem from the one investors were discussing at the beginning of the year.

Inflation is above the ECB’s 2% objective.

Growth is recovering modestly.

The ECB therefore does not face an obvious reason to reverse course towards lower rates.

Its deposit facility rate remains at 2.25% following the June increase and July hold. The Governing Council continues to emphasise that future decisions will depend on incoming inflation, underlying price pressure and economic data.

A Reuters poll before the latest activity data expected another ECB increase in September.

That provides the euro with something it lacked during several earlier dollar declines: its own potentially supportive rate story.

But Europe’s inflation problem is also heavily energy-driven

The euro’s support should not be overstated.

The largest July inflation component was energy, with prices 10% higher than a year earlier. Inflation excluding energy was only 2.2%, while the narrower measure excluding energy, food, alcohol and tobacco was 2.5%.

This distinction matters because an imported energy shock is not the same as broad domestic overheating.

The ECB may need to prevent higher energy prices from spreading through wages and services.

It does not necessarily need to offset every increase in oil and gas prices with higher interest rates.

The same Middle East tensions that are keeping euro-area inflation elevated are also damaging household purchasing power and raising production costs.

The euro therefore receives rate support from inflation while simultaneously carrying the economic cost of the inflation source.

That limits how aggressively traders can buy EUR/USD purely on the assumption of another ECB increase.

EUR/USD is now trading a double repricing

The current move is more interesting than a simple dollar sell-off because two expectations are changing at the same time.

On the US side, markets have reduced the probability that the Fed will tighten again in September.

On the European side, 2.9% inflation and more resilient activity make it harder to assume that the ECB’s June hike was necessarily the final increase.

The pair therefore receives support from both components of the rate differential.

The expected US rate path is moving slightly lower.

The expected European rate path is remaining relatively firm.

That is a much stronger foundation for EUR/USD than a rally driven only by temporary dollar positioning.

The question is whether Wednesday’s CPI allows that two-sided repricing to continue.

Why 1.16 has not broken yet

The hesitation below 1.16 does not necessarily mean the euro rally is weak.

It reflects the fact that the market has already made a substantial adjustment after payrolls and now faces a major event capable of reversing part of that adjustment.

EUR/USD at approximately 1.1558 is already near its strongest level since mid-June. The dollar index is near a two-month low and the probability of a September Fed move has fallen by more than 20 percentage points from a week earlier.

Buying aggressively immediately before CPI therefore requires confidence not just that the labour market is weak, but that inflation will cooperate as well.

That is a higher hurdle.

The jobs report opened the door above 1.15.

CPI determines whether the market walks through it.

Above 1.1600 would mean the market has changed the Fed story

A sustained move above 1.16 would be more significant now than it would have been before Friday’s jobs report.

The most convincing version would involve softer-than-expected US core inflation, falling Treasury yields and another reduction in September hike probabilities.

Under that combination, the market would be moving from:

“the Fed may still raise rates despite weaker jobs”

towards:

“the labour slowdown is now strong enough to prevent further tightening.”

That would materially reduce one of the dollar’s main advantages.

The euro would not need an aggressive ECB surprise to benefit.

It would simply need European data to remain sufficiently stable that markets do not simultaneously remove ECB tightening expectations.

Staying between 1.1500 and 1.1600 would tell a different story

A continued range around 1.15–1.16 would fit an economy where the jobs report weakened the Fed case but did not settle it.

US hiring would be soft enough to restrain rate expectations.

Inflation would remain too uncertain to price a clear policy reversal.

Euro-area growth and inflation would provide support, but not enough to justify an aggressive euro revaluation.

This outcome would make EUR/USD increasingly sensitive to each incoming US inflation release rather than to the payroll number already known.

The pair could effectively wait for the Fed debate to produce a winner.

A move back below 1.1450 would challenge the jobs-report rally

A sustained decline back below the area around 1.1450 would be more important.

It would suggest markets had initially overreacted to the payroll report.

The most obvious trigger would be stronger-than-expected US CPI, particularly if core inflation shows renewed monthly acceleration.

In that case, Treasury yields could recover and September hike expectations could rise again.

The weaker employment report would still matter.

But the market would conclude that the inflation problem is serious enough that the Fed cannot simply wait indefinitely.

EUR/USD would then return to the same difficult policy trade-off that limited the pair before payrolls.

The quality of the euro rally matters more than another few tenths of a cent

There are two very different ways EUR/USD can move above 1.16.

The weaker version would be driven almost entirely by another broad dollar liquidation.

The stronger version would combine softer US inflation with continued evidence of euro-area resilience.

The difference matters for durability.

A dollar-only move can reverse quickly if the next US report changes expectations.

A relative-fundamentals move is harder to unwind because both sides of the exchange rate are changing in the same direction.

Recent eurozone data have started to provide that second component.

Q2 GDP expanded 0.4%.

July business activity reached an eight-month high.

Inflation increased to 2.9%.

Germany produced several better industrial and export readings.

None of these figures is spectacular individually.

Together, they mean the euro is no longer depending entirely on US weakness.

The main risk to the euro remains another energy shock

The Middle East remains an important complication.

Brent crude was around $85 per barrel on Monday as uncertainty continued over the reopening of the Strait of Hormuz. Iran said an agreement with Oman on new shipping lanes was nearing completion but maintained other conditions for a broader resolution.

Higher oil affects both economies, but the transmission is different.

It can keep US inflation high enough to preserve Fed tightening risk.

For the eurozone, it also raises inflation, but Europe carries a greater direct exposure to imported energy costs.

A renewed oil surge could therefore create the uncomfortable combination of a more hawkish ECB and weaker European real growth.

That would make EUR/USD much harder to trade using rate expectations alone.

The euro benefits most from moderate inflation that keeps ECB policy firm without creating another major terms-of-trade shock.

EUR/USD assessment

Friday’s payroll report genuinely changed the EUR/USD outlook.

The US economy lost 23,000 jobs in July instead of adding the 80,000 expected by economists. May and June payrolls were revised down by a combined 103,000, leaving a much weaker hiring trend than markets had previously been trading.

That pushed September Fed hike pricing down sharply and drove the dollar towards a two-month low. EUR/USD consequently reached approximately 1.1558 on Monday.

But the move towards 1.16 is not simply a reaction to one disappointing American number.

The eurozone is providing more support of its own.

Second-quarter GDP increased 0.4%, July business activity reached an eight-month high and euro-area inflation rose to 2.9%. The ECB’s deposit rate remains 2.25%, with another increase still a realistic possibility.

That makes the current rally more credible than a purely position-driven dollar sell-off.

It is still incomplete.

US PCE inflation remains 3.7%, core PCE is 3.3%, and Wednesday’s July CPI report could quickly restore part of the Fed tightening argument if inflation surprises higher.

This is why EUR/USD has reached the door at 1.16 without clearly passing through it.

The employment report has already told the market that the Fed has less room to raise rates.

Now inflation has to decide whether the Fed has less need to raise them as well.

If Wednesday’s CPI confirms that message, the move above 1.16 would rest on something more substantial than a weak jobs report.

If inflation refuses to cooperate, the dollar may recover even though the labour market remains fragile.

For now, EUR/USD is no longer asking whether US employment has weakened. That question has largely been answered. The market is asking whether inflation will allow the Fed to respond to that weakness.