eur-usd

Weak momentum readings since the September high favors labeling the rally from 1.4480 as a 5th wave.  Wave v of C channel support is holding.  A daily close below the support line would shift focus to 1.4480 and then 1.3747 (wave iv low).  Above 1.5066 exposes the base of the topping formation from 2008 at 1.5280.

A major moderation in US Federal Reserve interest rate forecasts has meant that yield expectations generally favor Euro/US Dollar strength. Indeed, the European Central Bank is expected to raise rates by a cumulative 91 basis points in the coming twelve months—above forecasts for 80bp from the US central bank. The US Dollar is now effectively the lowest-yielding currency in the industrialized world, and yield-seeking investors have sold the USD on bullish risk sentiment.

Whether or not this may continue will almost solely depend on the trajectory of global risky asset classes. If markets continue higher, traders will likely continue to punish the low-yielding US Dollar versus higher-yielding counterparts.



The Euro remains the most overvalued of the majors against the US Dollar, trading 3735 pips above its PPP-implied “fair” exchange rate. While priced-in yield forecasts have oscillated substantially to give either the Fed or the ECB the advantage at a given point, the primary catalyst seems to be risk appetite. To that effect, a glance at equity markets to hint that a downward correction is around the corner: the MSCI World Stock Index fell the most in since February while the VIX index of US stock options volatility that is often seen as a proxy for investors’ risk aversion rose the most in a year in October. While it would be premature to say that a full retracement to the PPP exchange rate will materialize, some correction of the current valuation gap certainly looks plausible at this point.


What is Purchasing Power Parity?
   
One of the oldest and most basic fundamental approaches to determining the “fair” exchange rate of one currency to another relies on the concept of Purchasing Power Parity. This approach says that an identical product should cost the same from one country to another, with the only difference in the price tag accounted for by the exchange rate. For example, if a pencil costs €1 in Europe and $1.20 in the US, the “fair” EURUSD exchange rate should be 1.20. For our purposes, we will use the PPP values provided annually by Bloomberg. We compare these values to current market rates to determine how much each currency is under- or over-valued against the US Dollar.

Written by Ilya Spivak, Currency Analyst; David Rodríguez, Quantitative Strategist; Jamie Saettele, Senior Technical Strategist  for DailyFX.com

DailyFX provides forex news on the economic reports and political events that influence the currency market.
Learn currency trading with a free practice account and charts from FXCM.

• free demo account
• forex courses
• open an account
• real time news
• free webinars