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EUR/USD Recovery Proving Shallow Despite Rebound by Lira

EUR/USD Recovery Proving Shallow Despite Rebound by Lira

Christopher Vecchio, CFA, Senior Strategist

Talking Points:

- After trading through 7.00 yesterday, USD/TRY has reversed sharply, down by over -5% on the day, to under 6.52.

- But other currencies impacted by the Turkish Lira's sharp moves haven't staged a recovery of their own - concerns linger.

- Retail traders are continuing to buy EUR/USD and GBP/USD, leaving us with a bullish outlook for the US Dollar.

See our longer-term forecasts for the US Dollar, Euro, British Pound and more with the DailyFX Trading Guides

USD/TRY Reversal Boosting Market Sentiment...

The US Dollar (via the DXY Index) is set to lose ground for the first time after four consecutive days of gains, thanks in part to improved investor risk appetite around Tuesday's trading session. With focus remaining on Turkey, a sharp reversal in USD/TRY has market participants hopeful that any economic or financial fallout is contained to the country, and the collateral damage to emerging market or other currencies will be limited.

Price action developing today is essentially a mirror image of what we've seen since Thursday: the US Dollar is trading lower, as is the Japanese Yen; US equity futures are pointing higher, following their Turkish counterpart; and US Treasury yields are pushing higher. The demand for safe haven assets has been quelled.

But as far as the news goes, nothing material has changed over the past 24-hours that would lead us to believe that the situation is de-escalating at this point in time. Turkish President Recep Erdogan has pledged to retaliate against the US by boycotting the import of US electronic goods, and no timeline has been established to end the diplomatic schism surrounding the arrest of a US pastor.

USD/TRY Price Chart: Hourly Timeframe (August 2018) (Chart 1)

EUR/USD Recovery Proving Shallow Despite Rebound by Lira

It's important to put the USD/TRY reversal into content, then. While the stability in USD/TRY may be calming for market participants at present time, it won't do much to change the long-term calculus that the sharp depreciation in the Turkish Lira poses. Put simply, It's just a matter of time before loan defaults occur and financial insitutions start eating losses.

...but Pairs like EUR/USD Aren't Rallying

Despite the reversal seen in USD/TRY thus far, the losses are paltry compared to what would be needed in order to convince market participants that an economic and financial crisis in Turkey would be contained. With longer-term issues still at play - who is going to pay back all that money owed to the banks? - there hasn't been much scope for recovery for other impacted currencies.

Outside of the emerging market complex, the currency hit the hardest has arguably been the Euro. With European banks on the hook for $194 billion in loans to Turkish borrowers, there is the very real possibility that a wave of defaults in Turkey could spill over and adversely impact the balance sheets of European financial institutions.

In effect, it doesn't really matter then that USD/TRY has fallen by over -5% today; what matters is that the scale of the appreciation up to this point in time has been so severe that it poses the real risk of provoking a liquidity crunch for connected financial institutions down the road. This simple reality means that market participants are beginning to envision the European Central Bank stepping into to provide liquidity measures rather than withdrawing its QE and raising rates over the next year.

EUR/USD Price Chart: Daily Timeframe (June 2017 to August 2018) (Chart 2)

EUR/USD Recovery Proving Shallow Despite Rebound by Lira

Sizing up the EUR/USD recovery off of the lows makes for a fairly uninspiring read of the situation. The low in price yesterday coincided neatly with the 1.1300/70 region, which has been held up as both support and resistance going back to June 2016. But price remains below its daily 8-, 13-, and 21-EMA envelope, and both MACD and Slow Stochastics continue to point lower.

Accordingly, with the EUR/USD triangle breakdown having just transpired, and the Turkish Lira fallout likely to be in the news headlines for the foreseeable future, the most appropriate interpretation of today's price action is to view it as an opportunity to short EUR/USD on swings higher (and in turn, continue buying dips in the DXY Index).

Read more: FX Week Ahead: Turkey, UK CPI, US Retail Sales, and Aussie Jobs

FX TRADING RESOURCES

Whether you are a new or experienced trader, DailyFX has multiple resources available to help you: an indicator for monitoring trader sentiment; quarterly trading forecasts; analytical and educational webinars held daily; trading guides to help you improve trading performance, and even one for those who are new to FX trading.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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