The EUR decline has started to stall and EURUSD is moving sideways after the bears decided to take a breather at 1.2860 – the low from 9th September. This pair was starting to look overextended, so, for now, it looks like the EUR has fallen far enough, but that does not mean that another leg lower may not be around the next corner.
The fundamental picture could turn decidedly bearish for this pair next week as the FOMC holds its final meeting before ending its QE3 programme. The market is expecting a hawkish statement from the FOMC, and is looking for signs that the Fed is getting ready to embark on its first interest rate hike, potentially sometime in early 2014.
This could focus minds on the contrasting stances of the ECB and the FOMC, which could be dollar positive. As you can see in figure 1, the interest rate differential between German 2-year bond yields and two year US Treasury yields, is still deep in negative territory at -60 basis points, which has weighed on EURUSD. However, this spread is at its lowest level since 2006, so if Janet Yellen and co. at the Federal Reserve are not as hawkish as the market expects then it could be hard to push EURUSD any lower.
But EURUSD bears do not need to give up hope quite yet. It looks like the ECB is happy to watch the single currency slide south. ECB Governing Council member Luc Coene said on Friday that a falling currency is rather helpful, and he added that the decoupling from US monetary policy has been successful. Thus, don’t expect the ECB to change its dovish tune any time soon, which could limit EUR gains.
The technical view
As we mention above, this pair is in consolidation mode. This pair was looking extremely oversold, so a pullback at this stage is natural. We expect resistance to hold at 1.2975, the 38.2% Fib retracement of the sell-off from September 3 – 9th. We expect selling interest to build around this level, which could trigger a fresh leg lower with key support at 1.2787 – the 61.8% Fib retracement of the July 2012 – May 2014 bull trade, as you can see in figure 2.
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