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EUR/USD Up After Fed Hike but Skating on Thin Ice

The U.S. dollar took a turn to the downside on Wednesday following the July FOMC announcement. Although the Fed raised interest rates by 25 basis points to 5.25%-5.50%, it did not adopt an aggressive outlook, with Chairman Powell refraining from definitively signaling further policy firming. The overall tone drove Treasury yields lower, pushing EUR/USD towards the 1.1100 handle.

The euro’s gains, however, could be short-lived if the European Central Bank embraces a conciliatory stance at the end of its next meeting. For context, the institution led by Christine Lagarde is seen lifting borrowing costs by a quarter point on Thursday, but forward-guidance could shift in a dovish direction in the face of the deteriorating health of the economy in the region.

If ECB fails to commit to another rate rise and takes up a data-dependent approach, traders may begin to increase wagers that the hiking cycle is over, pricing out the probability of more tightening in September. This could trigger a sharp downward correction in the euro, causing the common currency to erase part of its 2023 rally.

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