EUR/USD bulls received an important boost on Friday, although further confirmation is still needed before the pair can extend meaningfully higher. The catalyst was the U.S. July payrolls report, which suggested labor market conditions softened compared to earlier in the year. Nonfarm payrolls came in at -23,000 versus expectations of +80,000, while June's figure was revised sharply lower to 20,000 from an initially reported 50,000. Average hourly earnings also disappointed on both a month-over-month and year-over-year basis, and the labor force participation rate slipped to 61.4% from June's 61.5%.

This weaker data triggered a sharp selloff in the dollar and U.S. Treasury yields, as traders scaled back expectations for a September Fed rate hike. According to the CME FedWatch Tool, the probability for a 25 bps hike fell to 45% from 55% the previous day. The dollar's yield advantage over the euro narrowed, though only modestly, with U.S.-German 2-year yield spreads tightening. Together, these developments pushed EUR/USD out of its recent consolidation range and up to a near two-month high.

However, even with this bullish backdrop, EUR/USD bulls appear reluctant to fully commit ahead of next week's U.S. CPI and PPI reports, which will provide fresh insight into inflation trends. With U.S. inflation breakevens and inflation-linked swap rates already trending lower, a below-consensus CPI/PPI print could validate market pricing and lead to further reductions in Fed tightening expectations. Such an outcome would likely pressure the dollar and yields further, potentially extending EUR/USD's rally off its July lows.
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(Christopher Romano is a Reuters market analyst. The views expressed are his own)