The EUR/USD exchange rate has formed three ‘higher highs’ since the 1.0534 lows, an observation that has helped us arrive at a positive stance on the pair for the week ahead.
The EUR to USD conversion remains stuck in a long-term, sideways trending range.
Markets are lacking fresh incentives to drive the exchange rate one way or the other it seems.
The ECB has stepped up its QE programme which has put a lid on any advances beyond 1.15 while the Fed outlook remains clouded by data and event risk, something that has prevented the pair falling towards parity.
The 2Y EZ-US spread has steadied around the 120/125 bps level for the past month confirming interest rate spreads are failing to have any meaningful impact.
What we do now know though, and this has been confirmed by the latest data from speculative markets, is that the traders are giving up on their negative bets against the euro.
The latest set of data from the IMM shows that EUR net shorts continue to erode as investors lose confidence in the prospect of the currency depreciating quickly in the near future. More range trade seems likely near-term.
Euro Upside Showing Fatigue
At the start of the new week we are seeing the euro come under a touch of pressure, largely in response to a general risk-off sentiment dominating markets.
"EURUSD continues to show signs of fatigue on the upside and we maintain that a decline is imminent. Losses however, may be limited by firm supports at 1.1388 – 1.1369," says analysts at Hong Leong bank in a foreign exchange briefing.
Nevertheless, the euro to dollar exchange rate pairing remains inside a year-long sideways range however of late the euro has retained the upper hand.
This is confirmed by the Chaikin Money Flow index on the weekly chart being marginally bullish, suggesting an eventual upside breakout out of the range and an establishement of a more sustained euro rally.
Indeed, a break above the range highs, which we estimate at 1.1495, would be the nail in the coffin of the longer-term down-trend.
A move above 1.1510 would provide further bullish confirmation for a range breakout.
The R2 Monthly Pivot at 1.1585 provides an initial target, given the propensity for pivots to rebuff price, however, the eventual target for the next move would be all the way to 1.2000, which is a significant round-number and psychological level.
Institutional Forecasts: Downside for Euro limited according to BNP Paribas
The euro has remained remarkably resilient to downside shocks, particularly the two recent European Central Bank (ECB) meetings in which the governing council announced an extension to its money printing programme and cut interest rates into negative territory.
According to strategists at French Bank BNP Paribas, this propensity to weather shocks is set to continue, resulting in limited downside for the EUR/USD pair.
The ECB is unlikely to increase money printing bar delaying the end-date of their current monthly programme to later than the current March 2017 deadline.
Taking Draghi for his word, they do not see the ECB lowering interest rates any further either. With no sign of a material change in ECB policy the euro is unlikely to see further weakness from that source.
Another factor in the single currency’s favour is the fact that according to Paribas’s model of fair value the euro is undervalued by 16%, and although this is “not unusual” it does mean further decline is unlikely.
Finally, the large current account surplus enjoyed by the euro-area, currently averaging 25bn per month, further bolsters the currency.
The current account is the difference between in-flows and outflows for a country, and a surplus means more money is coming in, which translates into greater net demand for the currency.
This factor is unlikely to end soon as it is increased by global uncertainty and struggling emerging market (EM) economies.
Normally outbound investment into EM and risky foreign assets balances the current account but this is not likely to be the case, given the global outlook and tumble in commodity prices.
A negative outlook for the global economy isn’t just supportive of the current account surplus but also because the euro’s low interest rates (the ECB’s refi rate is currently at 0.00%) and its liquidity, mean it is a favourite for investors funding riskier higher yielding investments.
When markets panic and investors pull out of those risky foreign investments the euro sees a lot of ‘buying back’ as funds are repatriated, which further supports it.
German Politicians Looking to Block Further Interest Rate Cuts
The ECB is facing stiff opposition to further interest rate cuts from prominent politicians in Germany, the Eurozone's key player.
A growing number of conservative German politicians have criticised the ECB over recent days for its interest rate policy, which they say is hitting the retirement provisions of Germans and could lead to asset bubbles.
Interestingly, German Finance Minister Wolfgang Schaeuble partly blamed the ECB's policy for the success of the right-wing Alternative for Germany (AfD) in recent regional elections, which saw it take up to a quarter of votes in a setback to Schaeuble's conservatives, according to the Wall Street Journal.
The Journal quoted Schaeuble as saying he had told ECB President Mario Draghi: "Be very proud, you can attribute 50 percent of the results of a party that seems to be new and successful in Germany to the design of this monetary policy."
"The ECB is taking a very risky path," Transport Minister Alexander Dobrindt told German newspaper Welt am Sonntag, adding that the central bank's policy signalled to citizens that there was no point in saving or putting money by for their retirement.
"The disappearance of interest is creating a gaping hole in citizens' retirement provisions so the efforts many people are making to ensure their prosperity in old age could vanish into thin air," said Dobrindt, a member of the Christian Social Union (CSU), the Bavarian sister party to Chancellor Angela Merkel's Christian Democrats (CDU).
Other key politicians have been quoted by Reuters as being unhappy with the ECB's policy on interest rates and would suggest the central bank will have another formidable stumbling block to overcome if it is to cut interest rates further.
This is an unambiguously positive development for the euro.
Dollar Outlook Negative
In contrast with the euro the dollar’s outlook is negative and made worse by global uncertainty.
The recent minutes of the Federal Reserve’s March meeting were peppered with references to the negative impact that global factors were having on the US economy.
Janet Yellen’s speech to the Economic Club of New York was characterised as cautious.
The bottom line is that the Federal Reserve is unlikely to raise interest rates any time soon.
A negative outlook for the global economy also means this state of affairs is unlikely to change in the near-term robbing the dollar of any supporting back-draft.
The recent news that Chinese bonds have experienced the largest weekly drop in two months, is not a good short-term sign for the Chinese economy or her equity markets as these often follow in the footsteps of bonds.
Next week sees increased risk from the release of Chinese Q1 GDP data. A disappointing fall in GDP will hit risk sentiment globally.
Bad news from China is likely to have a binary effect on EUR/USD given the opposite reactions of the two currencies to global risk aversion, with an overseas catalyst the potential driver for more upside in the pair.