EUR/USD: TLTRO risk could trigger another leg lower

Both the fundamental and the technical pictures seem to be stacking up against this pair today. From a fundamental perspective, positive Euro area data surprises are lagging behind those in the US. While the Eurozone saw its trade surplus contract, the US Empire manufacturing survey (a good early indicator of manufacturing strength) rose to its highest level in 5 years. Although US industrial production missed expectations, the run of data out of the US in recent weeks has generally been strong, August NFP notwithstanding.

The Organisation for Economic Co-Operation and Development (OECD) cut its forecast for growth in the Eurozone this year to 0.8% from 1.2% in its May assessment. The OECD also said that the ECB needs to do more to support growth in the Eurozone, including large-scale QE, to expand the amount of money in the financial system.

TLTRO test

This week is a big test for the Eurozone; if the Targeted Long Term Refinancing Operation (TLTRO) auction is not a success then we could see the EUR start to weaken. Although a lack of interest in these TLTRO loans would not expand the ECB’s balance sheet, it could pave the way for more QE down the line, which would expand the ECB’s balance sheet, which tends to be currency negative.

When the economic data is not on your side, and it looks like the central bank may be forced to take more accommodative monetary policy, this can be bad news for a currency. Thus, Thursday’s TLTRO auction is worth watching closely, anything less than a EUR 150 billion take-up could be viewed as a disappointment and may fuel speculation that QE from the ECB is on the way.

The TLTRO auction comes one day after the FOMC meeting on Wednesday. If we see a hawkish FOMC combined with weak demand for the ECB’s TLTRO loans, this could be a toxic mix for the single currency.

The technical view:

This pair is consolidating after selling off earlier on Monday, it has managed to find support at 1.2909, which coincides with Friday’s low. We could see some sideways action in the very short term as this pair had started to look over-extended to the downside. However, with Thursday’s TLTRO risk hanging in the balance, and the prospect of a hawkish statement from the Federal Reserve on Wednesday, then any upside in this pair could be short-lived.

Key resistance lies at 1.2980 – today’s high. If we get a rejection form this level, as we expect, then we would expect selling pressure to resume, and for EURUSD to eventually test critical support at 1.2787 – the 61.8% Fib retracement of the July 2012 – May 2014 bull trade.