EUR/USD Forecast: Overbought? ECB's inability to fight coronavirus opens door to more gains

California's declaration emergency overshadowed Italy's school closure, and as coronavirus extends its spread in Europe, it is only beginning to roam around the US. The upcoming week may see a limited response by the European Central Bank after the Federal Reserve's dramatic emergency cut -- and may extend EUR/USD's gains. 

This week in EUR/USD: Coronavirus spreads

After a week colored in red, financial markets were able to enjoy rallies. A promise for coordinate action by ministers and central bankers provided some hope, allowing for some short covering. However, for US treasuries, demand never seemed to stop -- and that pushed the dollar down alongside yields.

The Federal Reserve then surprised investors with an unscheduled rate cut of 50 basis points -- double the standard -- and in an unscheduled meeting. While it helped stocks, bond markets had a hunger for more and pointed to additional reductions of borrowing costs as soon as March 18 -- The bank's scheduled meeting.

Money markets price in a rate cut by the ECB, but that is limited to 10 basis points, thus having a limited negative impact on the euro. Moreover, the Frankfurt-based institution has limited space to act. Its deposit rate stands at -0.50%, deep in negative territory. 

The faster direction of travel of monetary policy -- not the favorable higher rates -- pushed EUR/USD higher. An economic advantage for the US, as confirmed by forward-looking Purchasing Managers' Indexes for February, was also ignored. 

Statistical data seems to lag behind the fast-moving virus which is wreaking havoc around the world. When Italy's death toll surpassed 100, Rome decided to close schools and universities until March 15. The dramatic move -- which undermines the productivity of parents to work at home -- temporarily weighed on the euro.

However, America's slow response in producing enough test kits and taking the illness with seriousness -- President Donald Trump called it a hoax at one point -- implies further potential damage to the world's largest economy. Fears only leaped when California confirmed its first coronavirus mortality and declared a state of emergency. Investors are realizing that the strong US economy -- and especially the home to Silicon Valley -- has more to lose. When Washington advanced a special $8 billion budget to fight the illness, investors were unimpressed. 

The dollar received a meaningful boost -- albeit insufficient to make it a winner -- from Joe Biden's victory in Super Tuesday's primaries in the Democratic Party. The centrist former Vice President enjoyed his victory in South Carolina and the backing of former rivals to overwhelm left-leaning Senator Bernie Sanders. While the race is far from over, markets are relieved that a more business-friendly candidate is now in the lead. 

The dollar another temporary boost from the excellent Non-Farm Payrolls report for February. It showed an increase of 273,000 jobs on top of upward revisions worth 85,000. Wage growth is healthy at 3% yearly. 

However, markets quickly shifted to worrying about the disease. 

See NFP Analysis: Superb data insufficient to stop the Fed from another double cut, USD vulnerable

Eurozone events: ECB action stands out

Contrary to the US, the old continent is still unwilling to introduce fiscal stimulus. Germany's reluctance to loosen its debt limits in the wake of the health crisis weighed on the euro in the last week of February and was forgotten afterward. If finance minister Olaf Scholz can convince Chancellor Angela Merkel to open Berlin's purse strings, the common currency has room to rise.

Until that happens, monetary accommodation is the only game in town. Christine Lagarde, President of the European Central Bank, has a substantial dilemma. If she pushes through a rate cut, it is unlikely to do much to help the eurozone economies and may only hurt banks. Moreover, she will find herself in a fight with hawks within the Governing Council. German and other members of the ECB opposed the latest rate cut and restart of the bank's bond-buying scheme in September. Lagarde aimed to soothe tensions and bring doves and hawks together by announcing a comprehensive strategic review. 

However, if she fails to act, the euro may rise and further hurt European exports and push inflation lower. The ECB's aims for 2% or close to 2% headline inflation and at 1.2% in February, it is far from achieving this goal. /Moreover, as a savvy politician, Lagarde wants to be seen as doing her part in alleviating pressure -- just like her peers all over the world.

A bolder and more effective step would be to step up its QE program from €20 billion per month to as much as the peak of €80 billion seen several years ago. For that, the ECB would need to loosen its self-imposed ruled and Lagarde would require additional work in persuading some skeptical colleagues in Frankfurt. 

Overall, it is a tough choice. For the euro, a rate cut of 10 bp to -0.60% is priced in. A deeper decrease of borrowing costs or announcing a large leap in the QE program would weigh on the common currency. Inaction would boost the common currency.

A few other noteworthy events may impact the euro. German Industrial Output figures -- which have been horrible in December -- are set to recover in the report for January. Another fall -- which would predate the coronavirus crisis -- would weigh on the common currency.

Final Gross Domestic Product figures for the fourth quarter are likely to confirm the sluggish expansion of the 19-country bloc while eurozone industrial output figures for January are impacted by the prior German release. 

Here are the events lined up in the eurozone on the forex calendar:

US events: Coronavirus and consumer data

The US dollar will likely move mostly on coronavirus cases, speculation about Federal Reserve action and the government's response to the disease. With more testing kits coming into play and few restrictions on movements, the number of cases will likely increase. In turn, economists may forecast weaker growth and further rate cuts -- thus weighing on the dollar.

President Donald Trump and Congress may change this potential course by upping their game and launching infrastructure and another spending -- not only to fight the virus but also to boost the economy. The current climate in Washington does not seem conducive for immediate action but may come later on.

The Democrats' primaries -- and polling toward the next races -- continue and could occasionally move the dollar. If Biden continues gaining ground, the greenback has more room to the upside. If Sanders makes strides towards recapturing his front-runner position, the dollar may decline.

Two economic indicators also have room to make it through the noise. The Consumer Price Index report for February is forecast to show a deceleration of headline inflation from 2.5% to 2.3%. More importantly, Core CPI is projected to remain unchanged at 2.3%. It is probably too early to see the impact of the virus on prices. In the future, the supply shock may push inflation higher. 

The second release is the University of Michigan's preliminary Consumer Sentiment survey for March. Is the public worried about the illness? A small drop is on the cards, but the level of uncertainty is high. 

Here are the scheduled events in the US:

EUR/USD Technical Analysis

Euro/dollar has shot above the 50, 100, and 200-day Simple Moving Averages and the currency pair is enjoying upside momentum. On the other hand, the Relative Strength Index is flirting with 70 – entering overbought conditions. 

This technical situation implies a downside correction before the rally resumes. An extension of the upside move is supported by the break above the long-term downtrend resistance that accompanied the pair since early 2019. 

Overall, a correction could be followed by a fresh rise. 

Support awaits at 1.1285, a resistance line from mid-2019. It is followed by 1.1240, December's peak. Next, the former triple-top of 1.1170 is critical support. It is followed by 1.1050, which played both roles in the past, followed by 1.0980, a low point in December. 1.0925 and 1.0880 are next. 

The first line of resistance is 1.1350, which capped EUR/USD around June. Next, 1.1405 was the summer's high point. It is followed by 1.1450, which was a peak in the spring. 1.1515 and 1.1550 are next.

EUR/USD Sentiment

Unless the ECB comes out with all guns blazing, EUR/USD has room to rise. It may extend its gains if Germany ups its game and the risk to the rally comes from the outside chance that the US halts the disease. All in all, the wind is blowing in favor of EUR/USD bulls.

The FXStreet Poll is showing that experts are skeptical about the recent rally and are bearish on all time frames. While the short-term target has been upgraded, medium and long-term goals have remained mostly unchanged.

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