EUR/USD Slumps and Flirts with Parity on EU Energy Crisis; US Inflation Data Eyed

EUR/USD OUTLOOK:

• EUR/USD sinks on Monday, hitting its lowest level in nearly two decades and flirting with exchange parity
• Fears that Russia may indefinitely shut down gas supplies to the European Union appears to be one of the main bearish drivers for euro
• June U.S. CPI data will steal the limelight this week. The report could act as a bullish catalyst for the U.S. dollar if inflation continues to surprise to the upside

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The euro took fire from different directions at the start of the week, suffering heavy losses against the U.S. dollar amid risk-off sentiment and broad-based DXY strength. At midday, the EUR/USD was down 1.1% to 1.0069, but earlier in the day it fell as much as 1.3%, flirting with exchange rate parity for the first time since late 2002.

Several catalysts weighed on the common currency on Monday, but the main bearish driver was fears that President Putin’s government would cut off some key energy exports to the European Union. PAO Gazprom temporarily shut down Nord Stream 1, the biggest single pipeline carrying Russian gas to Germany, for annual maintenance. Although flows are expected to resume in 10 days, investors speculate that the Kremlin could use the situation as an excuse to restrict gas supplies indefinitely in retaliation for sanctions imposed by the West following the invasion of Ukraine.

Should Nord Stream 1 remain out of service beyond the maintenance period scheduled to end on July 21, natural gas prices are likely to continue to rise expontentially and possibly surpass the March record, exacerbating the inflationary environment in Europe. This scenario will also create massive gas shortages in the region, prompting authorities to implement fuel rationing and, in the worst case, order brief shutdowns of factories to reduce energy consumption heading into the winter season, paving the way for what could be a deep recession.

The threat of economic warfare will be on every trader’s mind and depress the euro in the coming days until market participants have a better idea of what Russia plans to do next. Developments on the other side of the Atlantic, specifically in the United States, could also reinforce the EUR/USD’s bearish bias. June U.S. CPI data, duefor released on Wednesday, is expected to show annual inflation accelerating to a new cyclehigh near 9% on the back of soaring prices at the pump.

A red-hot CPI print will cement the case for another 75 basis points interest rate hike at the July FOMC meeting and possibly September, as policymakers are beginning to act more aggressively to upside inflation surprises. Monetary policy divergence between the Fed and the ECB, coupled with significant downside risks to growth in the Eurozone, will ensure that the US dollar maintains leadership in the FX space, a situation that may lock EUR/USD around parity in the near term.

EUR/USD TECHNICAL ANALYSIS

Following the EUR/USD’s recent slide, prices have fallen to multi-decade lows near 1.0000. To see what key technical levels are coming into play, it is necessary to turn to the monthly chart. Although there are no relevant zones of support in the vicinity, parity may act as a floor, but if sellers manage to breach that area to the downside, traders should brace for the possibility of a move towards 0.9625 through the third quarter. On the flip side, if dip buyers return and spark a bullish reversal taking into account the oversold state of the market, initial resistance appears at 1.0350. On further strength, the focus shifts upwards to 1.0665.

EUR/USD TECHNICAL CHART

EUR/USD Chart Prepared Using TradingView

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—Written by Diego Colman, Market Strategist for DailyFX