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EUR/USD, GBP/USD: Geo-Political Risk to Remain in Headlines

EUR/USD, GBP/USD: Geo-Political Risk to Remain in Headlines

2016-12-05 14:15:00
James Stanley, Strategist
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Talking Points:

- The Italian referendum over the weekend received a ‘no’ vote, and as expected Italian PM Matteo Renzi announced his resignation. After a brief burst of risk aversion, EUR/USD has put in an out-sized reversal following a brief visit to a well-tested zone of support.

- Tomorrow brings another Brexit hearing and while a verdict may not be heard until January, volatility in GBP/USD could certainly persist as GBP is one of the few currencies in the world that’s been as strong as the U.S. Dollar throughout the month of November.

- If you’re looking for trading ideas, check out our Trading Guides.

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Italian Referendum rejected, Renzi quits

While this wasn’t necessarily much of a surprise, the impending market reaction likely was. After closing last week near the 1.0660 level, EUR/USD broke down on last night’s open and continued to sell-off for about an hour and a half with very little buying or give back. But around 6:20 PM (approximately 1 hour, 20 minutes after the open of trading), EUR/USD ran into a critical support zone and stopped moving lower. By 7:10 PM, the bulls had appeared to have re-gained control, and as the European session opened last night, prices broke higher and continued to run in a bullish manner.

EUR/USD, GBP/USD: Geo-Political Risk to Remain in Headlines

Chart prepared by James Stanley

The long-term zone of support that EUR/USD ran into last night has been a rather stubborn area for the pair. This was the same price zone that quelled the declines in the Euro in March of 2015 as ECB QE was beginning to come online, and again in December of last year around an ECB meeting in which many were looking for the delivery of another ‘bazooka’ of stimulus.

Over the past month we’ve seen an aggressive rally develop in the U.S. Dollar, and even this has been unable to drive EUR/USD below this well-tested zone of support. This zone of support re-emerged on the charts a few weeks ago, at which point the aggressive-selling in EUR/USD appeared to slow. Notice the multiple attempts that prices made on the right side of the chart, only to have been rebuked on each approach.

EUR/USD, GBP/USD: Geo-Political Risk to Remain in Headlines

Chart prepared by James Stanley

The Euro hasn’t seen the end of the headlines this week, as Thursday brings on a widely-watched European Central Bank meeting that could certainly continue to prod volatility throughout Euro markets. At issue is whether or not the European Central Bank is going to extend their bond buying program that is currently set to expire in March of next year. This is the same bond buying program that led to the initial run-lower in the Euro in the summer of 2014, sending the pair all the way from the 1.30’s down to the current range with this zone of support around 1.0500.

If the ECB is unable to come to the table with more QE, we could see the top-side move in the Euro extend as QE bets continue to price-out of the market. For those that would like to use a bump-higher to position-in to longer-term bearish positions, the resistance levels below could offer some element of ‘anchoring’ for longer-term, short-side approaches:

EUR/USD, GBP/USD: Geo-Political Risk to Remain in Headlines

Chart prepared by James Stanley

Should resistance begin to show at one of these potential resistance levels after or around ECB later this week, particularly the two deeper resistance level sat 1.1213 and 1.1296, traders may be able to use the setup to position-in to longer-term bullish-USD positions.

Another Geo-political issue in the spotlight for tomorrow with another Brexit hearing…

Tomorrow the U.K. Supreme Court will hear the government’s case against holding a parliamentary vote before triggering Article 50. We probably won’t have a definitive answer on this until January. But – if the ruling is upheld and the government’s appeal fails, the idea of Article 50 being triggered before March seems significantly less-likely, and this could bring further gains into the British Pound. To read more, please check out this article from Martin Essex released earlier this morning.

The backdrop here is what makes this setup really interesting. Coming into October, there were very few reasons to be bullish on the British Pound. Not only had the currency put in a historic move around the Brexit referendum, but the Bank of England had been clear with their overt-dovishness in the effort of off-setting risks around Brexit. This extreme-passiveness from the BoE combined with the continued deluge in the spot price of the currency made for a daunting scenario for anyone looking to get long Sterling.

But rapid falls in a currency’s value has consequences, doesn’t it? Particularly for an import-heavy economy like the U.K., if a currency drops by 10 or 20% in a short-period of time, producers importing to that economy are probably going to have to raise prices (or they risk losing money by selling below breakeven if not accounting for the new, weaker currency values). And as these producers raise prices, we begin to see the initial stages of increasing inflation. This can then lead to increased inflation forecasts from the Central Bank, which could then bring on lessened-dovishness, and perhaps even eventually, increased hawkishness as investors prepare for higher rates in response to rising inflation.

Making matters more interesting here is the fact that while the U.S. Dollar spent much of November on a rampage, producing fresh 13-year highs, the British Pound was a dash-stronger throughout the month. On the GBP/USD chart, we can see support at higher-lows continually being defended, even while the Dollar was well-bid.

EUR/USD, GBP/USD: Geo-Political Risk to Remain in Headlines

Chart prepared by James Stanley

--- Written by James Stanley, Analyst for DailyFX.com

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