If the EURUSD decline from 15150 is unfolding as an impulse, then the pair will drop below 14216 before retracing a portion of the decline. On that note, consolidation since the December 22nd low is viewed as a corrective 4th wave; unfolding as either a triangle or flat. Continued strength should face resistance from 14500 and 14580. In the event of the expected low, there is potential support at 14120 and 14000. It is worth noting that January has produced the high or low for the entire year 18 times (11 highs and 7 lows) since 1980 (DEM rates pre 1998). In summary, weakness is expected near term, with support from 14000 to 14120.
A strong run of US Economic data has pushed US Federal Reserve interest rate expectations considerably higher in the past month, coinciding with a fairly substantive pullback in the Euro/US Dollar currency pair. Though correlation does not imply causation, intuitively the bounce in US Dollar yields has likely played a part in the currency’s sudden reversal. European Central Bank interest rate forecasts remain similarly bullish but mostly unchanged through the past month and give few new reasons to buy the Euro.
Whether or not resurgent Fed rate forecasts may continue to bolster the US Dollar may very well depend on the coming month of economic data. Traders should keep an especially close eye on December US Nonfarm Payrolls results, which could potentially break the uptrend in Federal Reserve interest rate expectations.
The Euro corrected lower in December but remains significantly overvalued against the US Dollar with prices still over 20% above the PPP-implied “fair” exchange rate. The single was the second-worst performing currency against the greenback last month while the spread between 1-year priced-in interest rate expectations for the Federal Reserve and ECB as narrowed substantially as US data took on a firmer tone, suggesting both momentum and yield considerations are supportive of further losses. The critical thing to keep watch out for as 2010 gets going will be whether the market will return to a risk vs. safety dichotomy that characterized much of the previous year or extend the shift towards a focus on economic fundamentals that began to take root towards the final weeks of 2009. The former scenario would offer some support to the single currency, while the latter would allow for continued weakness. On balance, our bias remains bearish.
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.
EUR / US Dollar Exchange Rate Forecast
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