View: EUR bounce has frail foundations, sell rallies leaning on EUR/USD1.2727
EUR price action has looked more constructive in recent weeks, having bounced to the 1.2407 resistance line at the start of the month finally punching through this on Tuesday amid on-going hopes that European officials were ready to be more interventionist in tackling the debt crisis. This speculation had culminated in a Der Spiegel article suggesting the ECB was looking at a plan to cap periphery yields at specified levels which has proven so exciting to participants that even ECB and Buba downplaying has been shrugged off. Indeed, the market is so optimistic that German 2-year yields brushed back into positive territory this morning as EUR/USD itself trades in the 1.2450/60’s, shrugging off a weaker equity market performance on the back of more worrying data out of Asia, specifically the Japanese trade numbers which showed an alarming 8.1% y/y drop in exports with sales to China falling at 11.9% and to the EU down an alarming 25.1% from a year earlier.
This is the rub really, while there are hopes that the Eurozone might actually do something substantial this is rhetoric at the moment and even if there was a concrete plan we already know there is a well-trodden path of the reality being far less effective and extended than initial aspirations, the core remaining fearful of the moral hazard effect of any softening of terms. Moreover execution depends upon requests for support and with Spanish yields down some 150bps from recent highs that bailout letter in PM Rajoy’s pocket will have gone for another Siesta. And of course there are risks surrounding the ESM itself with the German Constitutional court due to rule on its legality on September 12th, having the power to request certain restrictive caveats in order to meet its criteria which may yet dilute its effectiveness. This happens on the same day as the Dutch elections where anti-bailout rhetoric is also resonating. Alongside this are the on-going demands from Greece to soften the terms of its existing bailout, Samaras on another charm offensive this week. All of this overlooks the fact that any willingness from the ECB to print will be a fundamental EUR negative too.
Meanwhile the local macro environment continues to worsen and there are growing global risks in the form of a faster - and therefore more difficult to manage - Chinese slowdown and the knock on effect this is having on the rest of Asia, à la Japanese exports. This presents a far more acute problem to the Eurozone block where in the face of weak domestic demand is ever more reliant on export demand. This is of course exaggerated by the German refusal to adjust their surplus model which the EUR has played a pivotal role in facilitating (i.e old DM would have been far stronger over the period) and is undoubtedly a contributor to the current periphery/core divide.
Such a backdrop isn’t one that suggests that we should be close to any meaningful change in the Euro’s mid-term trend, the current bounce very much a correction wave within the broader move that still points to EUR/USD1.1877 and then 1.0800, and longer-term to sub-parity. The key is when to begin to fade the current risk on/ short covering rally. On our charts the 1.2625 to 1.2727 area is really the first resistance zone that looks substantial although immediate trend resistance at 1.2577 should be the first point where we see better sellers step back in in the absence of any event that might lead traders to pull the trigger sooner. By then we should also see our indicators at more normalised levels, these currently supporting the upward bounce on a daily timeframe.
Any overshoot through this higher 1.2727 marker would set back the downtrend but not derail it; really the market needs to get back above 1.2820/24 to do that on weekly basis, something current fundamentals shouldn’t be able to facilitate. Once the market rolls over a daily reversal through 1.2288 would be the signal that the move is real and perhaps be a point to add further exposure, leaving the July low at 1.2043 vulnerable and increasing the draw of that key 1.1877 area which halted 2010’s Greek induced decline and needs to be cleared to keep the multi-year pattern of lower lows and lower highs in place.