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Talking Points:

- Today marks the end of Q2, and the reversals that have shown in the US Dollar, EUR/USD and GBP/USD have been notable, especially considering the prior year-plus trends that were previously showing in each market. As we move into the second-half of this year, the prospect of continued volatility remains as markets contend with a combination of a persistently-hawkish Federal Reserve, a dovish European Central Bank and a Bank of England with quite a few questions surrounding the August and November rate decisions set for later this year.

- In Q2, the major rate decisions of focus are the Fed’s September meeting in which markets are currently holding a 72.3% probability of a 25 basis point hike. The ECB’s September rate decision will likely be important, as well, as this is where the bank will announce details on execution of stimulus-taper. The August Bank of England rate decision is a ‘Super Thursday’ event, and if we don’t get a hike there, the focus will then move to November. But – inflation will remain key around the BoE, so if we see continued deterioration in that data point, odds for rate hikes will likely slim, and this could add even more pressure to the Pound.

- DailyFX Forecasts on a variety of currencies such as the US Dollar or the Euro are available from the DailyFX Trading Guides page. If you’re looking to improve your trading approach, check out Traits of Successful Traders. And if you’re looking for an introductory primer to the Forex market, check out our New to FX Guide.

Do you want to see how retail traders are currently trading the US Dollar? Check out our IG Client Sentiment Indicator.

Prominent FX Themes Pull Back Ahead of Q2 End

It’s been a giving back type of morning thus far as we’ve seen some of the more prominent FX themes from Q2 pull back as we approach the end of the quarter. In the US Dollar, prices have moved back-below the 95.00 level on DXY, and this has helped EUR/USD firm after another failed attempt at taking out the 1.1500 psychological level. But – this does not necessarily denote the end of these themes, as quarter-end can often bring counter-trend flows as traders and fund managers square up positions ahead of the Q3 open.

In yesterday’s webinar, we looked at which themes may remain as workable as we move into the second half of this year. Below, we’re going to look into a few of the more interesting scenarios that will likely remain on the front-burner for FX traders in the coming weeks and months. Of particular interest is the fact that we have two potentially divergent themes around the Bank of England and the British Pound and the European Central Bank and the Euro. This could create an interesting backdrop for USD-strength in EUR/USD, while the possibility of reversal setups in GBP/USD gets a bit more attractive as we move towards the August BoE rate decision.

US Dollar Strength: Was Q2 an Aberration or the Start of a Fresh Bullish Trend?

Probably the biggest FX take-away from Q2 was the re-emergence of US Dollar strength. After the Presidential election in 2016, the Dollar remained really strong as we traded into 2017, and this took place alongside a rally in US equities. That US Dollar strength started to turn early last year while stocks continued to take-off, and this left many puzzled as to why the Dollar was so weak when the Federal Reserve was one of the few major Central Banks actually looking at higher rates.

With a bit of hindsight, we can now see that this was a shift towards Europe in anticipation of higher rates there, expecting that the ECB would have to play catch-up with rate normalization as the global recovery further took hold. This helped to contribute to that strong topside run in the single currency and, deductively, this took strength away from the US Dollar as the Greenback dropped by as much as 15% last year. This drop erased 61.8% of the previous 2014-2017 major move, and that support began to show in mid-February.

US Dollar Weekly Chart: Q2 Sees Strength Return After 61.8% Retracement of 2014-2017 Major Move

Please add a description for the image.

Chart prepared by James Stanley

What changed in Q2 was the ECB. They announced how they’re planning on exiting from stimulus, but they also negated the prospect of near-term rate hikes, continuing in a dovish and passive stance even as they look to taper their massive QE program. This theme could help to keep the bid behind the US Dollar as rates markets further focus on the five hikes that the Fed has planned out to the end of next year while the ECB may be looking at one hike in that span.

US Dollar via ‘DXY’ Daily Chart: Bullish Potential As We Move into 2H, 2018

us dollar usd daily chart

Chart prepared by James Stanley

EUR/USD Reversal of Bullish Trend: Prospects of a Deeper Drop

The Euro was incredibly strong last year considering the stance at the ECB. There were even hopes for a stimulus-exit announcement in October of 2017 as markets were gearing up to hear how the bank might look to taper their QE program. But when those hopes were dashed a quick spate of weakness showed in the Euro that lasted for about two weeks. This was soon offset by a red-hot German GDP report, and in short-order bulls were back at work, bidding the single currency-higher. That theme of Euro strength lasted a few weeks into Q2; but as economic data continued to sour, the door was open for the ECB to go even more dovish, and when this showed-up in April the Euro started to reverse that prior bullish trend.

In the month of May we saw European political risk re-enter the equation, and this took over as a dominant theme in the currency as sellers remained in-control for most of the month. This is when rumors started to float that the ECB would announce stimulus exit at their next rate decision in June, and that helped to bring a pullback to that sell-off as markets geared up for the same thing that had kept the currency bid throughout last year.

But when the announcement came, it was coupled with a warning that the ECB was looking at keeping rates at current levels ‘at least through the summer of 2019,’ and this alludes to the fact that we might be seeing five more rate hikes out of the Fed during a period in which the ECB may be looking at one. Rate-hike bets for a move out of the ECB in June of last year were quickly priced-out of the market, and Euro weakness has been a fairly visible theme ever since.

EUR/USD Four-Hour Chart: Rally in Early-June Quickly Reversed At June ECB Rate Decision

eurusd four hour chart eur/usd

Chart prepared by James Stanley

As we move into Q3, the big question is whether EUR/USD can take-out 1.1500. We’ve already seen three failed attempts, most recently yesterday morning after bears got shy when we were approaching that prior swing-low. Key for this theme will be European inflation, which has been surprisingly strong over the past two months, along with the ECB rate decision in September. If we are able to see a break-below 1.1500, the area around 1.1200 becomes attractive for the next stop of support, as this is a confluent zone that helped to define resistance ahead of last year’s bullish incline.

EUR/USD Weekly Chart: Holding Trend-Line Support as Q2 Winds Down

eurusd eur/usd weekly chart

Chart prepared by James Stanley

GBP/USD with Reversal Prospects After a Brutal Q2

It was a rought second quarter for the British Pound.

We came into the quarter flying-high on the hopes of getting a rate hike out of the BoE at the bank’s ‘Super Thursday’ rate decision in May. But just a couple of weeks into the second quarter and the odds for that move started to drastically diminish, let by a deterioration in economic data. Inflation slowed, GDP printed in a rather disappointing manner, and similar to what was seen at the ECB in April, the door was opened for the Central Bank to take a step in the dovish direction.

This led to a drop by as much as 1,300 pips in Cable over the past couple of months, an outsized move by many standards, and as we move into Q3, we’re again looking at the potential for a near-term rate hike at the BoE.

What changed is the BoE itself, as inflation remains well-below the 3% prints that we saw last year. But at the last rate decision, we saw three dissenting votes cast for an immediate rate hike, and this included the bank’s Chief Economist, Andy Haldane. This has helped to build odds for a potential rate hike in August, and this could potentially help to draw some strength into the currency.

The big question in Cable is what happens at 1.3000. This is a key psychological level in the pair, and this could be an interesting point with which to base reversal setups, particularly if we do see a grander shift at the Bank of England in Q3. We may not even need a rate hike in August to do it, as that meeting could be used to lay the groundwork for a November move; and even those prospects might be enough to help to reverse the tide of weakness that’s recently shown in GBP.

GBP/USD Daily Chart: Approaching 1.3000 Psychological Support After Brutal Q2 Reversal

GBPUSD gbp/usd daily chart

Chart prepared by James Stanley

To read more:

Are you looking for longer-term analysis on the U.S. Dollar? Our DailyFX Forecasts for Q1 have a section for each major currency, and we also offer a plethora of resources on USD-pairs such as EUR/USD, GBP/USD, USD/JPY, AUD/USD. Traders can also stay up with near-term positioning via our IG Client Sentiment Indicator.

Forex Trading Resources

DailyFX offers a plethora of tools, indicators and resources to help traders. For those looking for trading ideas, our IG Client Sentiment shows the positioning of retail traders with actual live trades and positions. Our trading guides bring our DailyFX Quarterly Forecasts and our Top Trading Opportunities; and our real-time news feed has intra-day interactions from the DailyFX team. And if you’re looking for real-time analysis, our DailyFX Webinars offer numerous sessions each week in which you can see how and why we’re looking at what we’re looking at.

If you’re looking for educational information, our New to FX guide is there to help new(er) traders while our Traits of Successful Traders research is built to help sharpen the skill set by focusing on risk and trade management.

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

Contact and follow James on Twitter: @JStanleyFX