View: EUR/USD to resume mid-term downtrend, add to shorts on any s/t blip higher
Thanks to some encouraging words from Draghi in early August the EUR found decent traction in financial markets, rallying nearly 1.9% in trade weighted terms over the past month. And as ever the improvement has led to a flurry of more bullish EUR calls from analysts, anticipating decisive action from Eurocrats, specifically the ECB where at tomorrow’s meeting the consensus seems to be there will be clarity on the touted bond purchase programme, which would naturally be good for the single currency. Furthermore the market has had the prospect of more QE from the Fed to lean on which in the past has been generally good for that other currency heavyweight (using the term very loosely), reinforcing all this intellectual front running.
This conjecture is a little odd to us, even in very basic terms the prospects for more ECB money printing – however disguised – is a currency negative. To have any meaningful impact on the regional economy the ECB is going to have to be aggressive (in size) and far more than the Fed where the battle is against slow growth rather than recession. Even the OECD is calling on the Eurozone’s central bank to commence ‘unlimited’ bond purchases of peripheral debt, acknowledging the reforms already enacted and Draghi himself has said how the ECB could buy tenors out to three years in the secondary markets without breaching its mandate. The gap in the plan is really what sort of conditionality would be attached to this, assuming the ESM makes it past the German Constitutional Court. Even if details of this strategy are not immediately forthcoming (ECB should wait until the immediate legal hurdles are passed) we know the bias in the region is for an easing of monetary policy anyway. You don’t have to look beyond the continually gloomy macro data to see that.
This entire move up in EUR/USD seen in this context is very much correctional, a consequence of the improvement in risk appetite which has been evident across many markets this summer. But as fundamentals reconnect the cross should roll over and resume the mid-term downward trend. As we’ve noted a couple of times the first really decent level to look to position short with this in mind was 1.2625, the January low, which was tested and rejected at the end of last week and again on Tuesday. This should reinforce this resistance area now and even with the risk of the ECB meeting tomorrow looming our bias would be to maintain shorts built at these levels with a view to seeing new lows for the year print in this cross.
The move lower on Wednesday morning which has taken the cross back to the 1.2505 line creates some convenient breathing space with all this in mind, probably enough to skirt the usual volatility seen at the ECB press conference with only a move back through 1.2638 likely to trigger a further bout of short covering and even then topside should be capped at 1.2727. Our preference would be to run shorts with a view to adding another clip if this scenario plays out leaning on 1.2821/47 which is where one would have to reassess. More vulnerable should be trend support rising from 1.2457, a breach of which would offer more decisive confirmation that the failure at the 1.2625 area is the top of this corrective bounce. The next level below there is 1.2383/1.2407 ahead of 1.2280 and 1.2163 which need to be ticked off before clearing the July low and moving on to test the 1.1877 level which is the real objective of the wave down.