EUR/USD falls below $1,06 on a stronger dollar and hawkish Fed

The common currency extended recent losses by falling below the $1,06 key support level this morning, for the first time since the early days of the year, giving up some significant gains of the latest rally, as the prospect of higher interest rate hikes from the Federal Reserve is favoring the dollar against the euro.

EUR/USD pair hit a six-week low of $1,0580 this morning after data released Friday showed that Germany, the Eurozone’s largest economy contracted at the end of the year, shrinking by 0.4% vs expected -0.2% in the fourth quarter of 2022 compared with the previous three months.

EUR/USD pair, Daily chart

A lower-than-expected German Q4 GDP is a negative/bearish catalyst for the common currency, especially on a day like this today, which completed a year since Russia’s invasion of Ukraine, which tanked the EU economy.

Euro’s retracement from early February’s highs of $1,10 to the current lows is part of a broader rebalancing in the forex market in favor of the U.S. dollar against major G10 growth-sensitive currencies such as the Euro, Pound Sterling, and the Australian dollar as the market sentiment remains fragile amid fears of a more hawkish Federal Reserve to curb inflation.

Investors have increased their worries about more interest rate hikes by the Federal Reserve in recent weeks, following some stronger-than-expected U.S. macroeconomics, labor, and inflation readings, which are signs of resilience in the world’s largest economy.

The fundamentals are now favoring the dollar against the euro as investors braced for U.S. interest rates to be higher for longer, with the DXY-U.S. dollar index, which tracks the value of the greenback against six major peers, climbing over 104,70 this morning ahead of a reading on the PCE-Personal Consumption Expenditures index - the Fed’s preferred inflation gauge.

The PCE price index is a wide indicator of the average increase in prices for all domestic personal consumption and is widely expected to reiterate that U.S. inflation remained elevated in January.