EUR/USD Outlook: Awaits hawkish Fed before the next leg down to a two-decade low

• EUR/USD came under renewed selling pressure on Tuesday amid resurgent USD demand.
• Bets for aggressive Fed rate hikes trigger a sharp spike in the US bond yields and the USD.
• Bearish traders turn cautious and await the crucial FOMC policy decision on Wednesday.

The EUR/USD pair witnessed an intraday turnaround on Tuesday and retreated nearly 100 pips from a one-week high, reversing its modest gains recorded over the past four sessions. The US dollar caught aggressive bids as investors geared up for another supersized interest rate hike from the Fed and turned out to be a key factor exerting downward pressure on the major. The current market pricing suggests over 80% chances of a 75 bps increase and a small probability of a full 100 bps tightening. This, in turn, pushed the US bond yields higher across the curve and provided a goodish lift to the greenback.

The two-year US government bond yield, which is highly correlated to rate expectations,  jumped to its highest level since October 2007. Furthermore, the benchmark 10-year US Treasury note reached a level not seen since April 2011. This, along with the risk-off impulse, acted as a tailwind for the safe-haven buck. The market sentiment remains fragile amid concerns that rapidly rising borrowing costs will lead to a deeper global economic downturn. The headwinds stemming from China's zero-COVID policy and the protracted Russia-Ukraine war have fueled recession fears.

On the economic data front, the German Producer Price Index (PPI) climbed 7.9% in August and the yearly rate rose to 45.8% from 37.2% in the previous month. In the US, Building Permits fell by 10% in August, while Housing Starts were up by 12.2% during the reported month. The market reaction, however, was muted as the focus remained on the critical central bank event risk. Even comments by the European Central Bank President Christine Lagarde, saying that the appropriate pace of future rate increases will be decided on a meeting-by-meeting basis, failed to provide any impetus to the EUR/USD pair.

Nevertheless, spot prices settled near the lower end of the daily trading range and remained on the defensive through the Asian session on Wednesday amid some follow-through USD uptick. Market participants now seem to have moved to the sidelines and await the highly-anticipated FOMC policy decision, scheduled to be announced later during the US session. Moreover, updated economic projections, the so-called dot plot and Fed Chair Jerome Powell's remarks at the post-meeting press conference will be examined for clues about the future rate-hiking path. This, in turn, will play a key role in influencing the near-term USD price dynamics and provide a fresh directional impetus to the EUR/USD pair.

Technical Outlook

From a technical perspective, repeated failures to find acceptance above the parity mark suggest that the bearish pressure might still be far from being over. Some follow-through selling below the 0.9950-0.9945 region will reaffirm the negative bias and make the EUR/USD pair vulnerable. The subsequent downfall could then drag spot prices to the 0.9900 round-figure mark en route to the 0.9865 region, or the lowest level since 2002 touched earlier this month.

On the flip side, the 1.0000 psychological mark now seems to act as an immediate strong barrier ahead of the 1.0030-1.0050 supply zone. Sustained strength beyond the latter might trigger a short-covering rally and lift the EUR/USD pair to the 50-day SMA resistance, just ahead of the 1.0100 round figure. Some follow-through buying will suggest that spot prices have formed a near-term bottom and pave the way for a move towards the 1.0145-1.0150 intermediate barrier. Bulls might then aim to conquer the 1.0200 mark.