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Further Euro Upside Possible Without ECB Interference - a Big 'If'

Further Euro Upside Possible Without ECB Interference - a Big 'If'

2016-04-03 23:45:00
Christopher Vecchio, CFA, Senior Strategist
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Further Euro Upside Possible Without ECB Interference - a Big 'If'

Fundamental Forecast for EUR/USD: Neutral

- EUR/USD quickly moved into a bullish breakout posture after Fed Chair Yellen’s comments.

- Despite a ‘good enough’ US jobs report, EUR/USD’s ascent was only momentarily stalled intraday.

- As market volatility ebbs, it's a good time to review risk management principles.

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The Euro finished out the quarter on mostly strong footing, rallying further against recently embattled currencies like the British Pound (EUR/GBP +1.31%) and the US Dollar (EUR/USD +1.97%). Yet with commodity prices, mainly Crude Oil, slumping again, the commodity currencies weren’t able to post sizeable gains (if at all; EUR/CAD rallied by +0.01%) around the latest round of dovish commentary from Federal Reserve Chair Janet Yellen.

As EUR/USD appears to be primed for a technical breakout to the topside thanks to the Fed, it comes against the backdrop of the European Central Bank recently admitting that its latest measures aren’t aimed at the FX channel. For more information on this, and why we diagnosed the Euro as having greater potential for upside immediately after the ECB’s March 10 reading, you might find the Euro weekly trading forecast from the week of March 13, 2016 helpful, “ECB’s Measures Aimed at Credit, Not FX – Euro Gains Breathing Room.”Now that the ECB’s new easing measures are in effect (as of this Friday, the start of Q2’16), further Euro upside wholly depends on the ECB keeping quiet about the Euro’s exchange rate.

To be clear, now that some the latest tweaks to the ECB’s easing measures are in effect – notably the increased pace of asset purchases, up by €20 billion to €80 billion per month – the Euro may be a bit more susceptible to weakness if risk markets rally (the portfolio rebalancing channel effect is still in play). However, the sensitivity the Euro will have to gains by equity markets and lower core sovereign yields may be limited thanks to Fed Chair Yellen’s heightened dovish posture.

It seems, then, that without the ECB interfering, the Euro, particularly via EUR/USD, has a slight upside bias in the near-term. Recent technical developments seem to agree with this view. In the past, when EUR/USD has strayed too far to the upside from the ECB’s technical assumption, ECB officials have been quick to counter the exchange rate appreciation with verbal intervention. If we are to take the ECB at face value with their recent shift away from the FX channel, it may mean that the threshold for pain – how far EUR/USD is allowed to rally before it becomes a concern once more – has increased.

With a fair amount of net-short positions held by speculators in the futures market – 63.8K as of the week ended March 29, 2016, but still a far cry from the 226.6K net-short contracts held for the week ending March 31, 2015 – there is room for short covering to keep the Euro cushioned.

If the ECB does have a threshold for pain, the August 24, 2015 high (around the Chinese equity market meltdown) at $1.1714 looks to be a good a place as any to become especially skeptical of EUR/USD, should it get that high. Likewise, with EUR/GBP trading above £0.8000 (and on its way to the £0.8060/0.8100 target outlined in mid-January), we think there is good reason to distrust the Euro – but a little bit further down the line from now.

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If you haven't yet, read the Q2'16 Euro Forecast, "EUR/USD Stuck in No-Man’s Land Headed into Q2’16; Don’t Discount ’Brexit’," as well as the rest of all of DailyFX's Q2'16 quarterly forecasts.

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

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