EUR/USD Rates Threaten Triangle Bearish Breakout after New ECB President's Remarks
Top FX Headlines Talking Points:
- With incoming European Central Bank President Christine Lagarde saying that the central bank “hasn’t hit the lower bound on interest rates,” traders are pricing in a more aggressive rate cut path.
- Overnight index swaps are currently pricing in a 100% chance of a 10-bps rate cut at the September ECB meeting, but odds of a 20-bps cut have increased from 10% to 26% over the past day.
- The IG Client Sentiment Index suggeststhe combination of current sentiment and recent changes gives us a stronger EURUSD-bearish contrarian trading bias.
The final weeks of August are usually a quiet time for global financial markets as computer screens are traded for sunscreen. But this year has been different: with the US-China trade war raging, the October 31 Brexit deadline coming into focus, and global growth concerns coming into focus, the news wire has been a veritable source of event risk as market participants await comments from politicians and central bankers alike to help guide their investment decisions. Today has proven no different.
Incoming ECB President Sounds Very Dovish
There’s no reason to split hairs: incoming ECB President Christine Lagarde sounded very dovish this morning across prepared remarks to the European Parliament. Starting softly, the ascendant central banker noted that the ECB has a “broad tool kit” and “must stand ready to act.” So far, par for the course; she sounds like outgoing ECB President Mario Draghi.
But where Lagarde differs from Draghi may be her willingness to go more dovish in a forceful manner, in a short period of time. In her letter to the European Parliament, Lagarde noted that the ECB “hasn’t hit the lower bound on interest rates,” suggesting that, unlike her predecessor, she will be willing to aggressively push interest rates deeper into negative territory.
September ECB Meeting Will Start Rate Cut Cycle
With incoming ECB President Lagarde turning up expectations for aggressive dovish policy action, interest rates markets have responded in kind by dragging forward rate cut expectations. At the end of the day yesterday, according to overnight index swaps, there was a 100% chance of a 10-bps rate cut at the September ECB meeting and a 10% chance of a 20-bps cut.
European Central Bank Interest Rate Expectations (August 29, 2019) (Table 1)
Now, after Lagarde’s comments, overnight index swaps are still pricing in a 100% chance of a 10-bps rate cut at the September ECB meeting but are now pricing in a 26% chance of a 20-bps rate cut in September. There is a 69% chance of a second 10-bps rate cut coming in October, while there is an 82% chance of the second 10-bps of rate cut at the December ECB meeting. Rates markets are pricing a third rate cut over the next 12-months coming in January 2020.
Eurozone Economic Data Still Disappointing
For the ECB, there may be good reason to look to cut interest rates. The Eurozone’s largest economy, Germany, is quickly approaching a ‘technical’ recession, or two consecutive quarters with contracting GDP. Overall, Eurozone economic data has remained disappointing in recent weeks, at least as measured by looking at economic data from an objective point of view.
The Citi Economic Surprise Index for the Eurozone, a gauge of economic data momentum, is currently at -41.3; one month ago, it was at -37.5. The disappointing streak of Eurozone data continues in in parallel with rising growth concerns swirling around the US-China trade war.
Eurozone Inflation Expectations versus Brent Oil Prices: Daily Timeframe (August 2018 to August 2019) (Chart 1)
Outgoing ECB President Mario Draghi’s preferred measure of inflation, the 5y5y inflation swap forwards, are currently trading at 1.2481%, lower than where they were one month earlier at 1.3315%, but still significantly above the yearly low set on June 17 at 1.141%. Regardless; these are market readings that will reinforce speculation for more easing from the ECB soon.
EURUSD TECHNICAL ANALYSIS: DAILY TIMEFRAME (OCTOBER 2018 TO AUGUST 2019) (CHART 2)
In our last EURUSD technical forecast update, it was noted that “the attempt by EURUSD to breakdown out of the symmetrical triangle has been thwarted in the form of a bullish key reversal/outside engulfing bar on the daily timeframe…The symmetrical triangle pattern is still neutral, but traders may want to focus on the topside potential once more.” This was only half correct: the triangle is indeed neutral; but traders should not be focusing on topside potential, instead, on downside potential.
The EURUSD symmetrical triangle that’s been forming since mid-July is now seeing support from the August 1 and August 23 lows come into focus near 1.1060. Price is now below the daily 8-, 13-, and 21-EMA envelope, while daily MACD and Slow Stochastics have turned lower in bearish territory. The August 23 bullish key reversal/outside engulfing bar low comes into play at 1.1052; below here, then a bearish breakout may be afoot.
IG Client Sentiment Index: EURUSD Rate Forecast (August 29, 2019) (Chart 3)
EURUSD: Retail trader data shows 68.2% of traders are net-long with the ratio of traders long to short at 2.14 to 1. In fact, traders have remained net-long since July 1 when EURUSD traded near 1.1397; price has moved 2.9% lower since then. The number of traders net-long is 4.9% higher than yesterday and 8.8% higher from last week, while the number of traders net-short is 1.1% lower than yesterday and 8.0% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EURUSD prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EURUSD-bearish contrarian trading bias.
EURJPY TECHNICAL ANALYSIS: DAILY TIMEFRAME (FEBRUARY 2017 TO AUGUST 2019) (CHART 4)
In our last EURJPY technical forecast update, it was noted that “by market close on Friday, August 23, EURJPY had broken out of its symmetrical triangle to the downside.” There hasn’t been much follow through in recent days, however: the Friday close was at 117.42; EURJPY rates have traded between 116.56 and 118.20 this week (1.38% range).
The lack of follow through in the bearish breakout has seen momentum indicators like daily MACD and Slow Stochastics turn higher, albeit holding in bearish territories. EURJPY rates are holdingat the daily 8-EMA, and remain below both the daily 13-, and 21-EMAs. The 100% Fibonacci extension of the September 2018 high to January 2019 low to March 2019 high move comes in at 113.21, which looks increasingly in playthe longer that EURJPY spends below the 61.8% Fibonacci extension at 118.67.
EURJPY TECHNICAL ANALYSIS: WEEKLY TIMEFRAME (2008 TO 2019) (CHART 5)
Big picture: we may be witnessing the early phases of what could be a long-term downtrend for EURJPY with the weekly timeframe suggesting a loss of triangle support from the 2012 and 2016 lows and recent swing support at the January 2019 Japanese Yen flash-crash low at 118.82.
IG Client Sentiment Index: EURJPY Rate Forecast (August 29, 2019) (Chart 6)
EURJPY: Retail trader data shows 66.5% of traders are net-long with the ratio of traders long to short at 1.99 to 1. In fact, traders have remained net-long since April 25 when EURJPY traded near 125.28; price has moved 5.7% lower since then. The number of traders net-long is 2.5% higher than yesterday and 26.8% higher from last week, while the number of traders net-short is 7.4% higher than yesterday and 0.4% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EURJPY prices may continue to fall. Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed EURJPY trading bias.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at firstname.lastname@example.org
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