Euro Sentiment at Extreme, Rally Low on Fuel with Light Calendar Ahead

Fundamental Forecast for EUR/USD: Neutral

- Although it gained versus every major currency, the Euro’s gains versus the US Dollar were kneecapped on Friday after an all-around solid July US Nonfarm Payrolls report.

- The Euro may be at a bullish extreme, according to three separate sentiment indicators, including our in-house sentiment reading, the IG Client Sentiment gauge.

- Review our Q3’17 EUR/USD forecast as make our way into mid-August.

The Euro was the top performing currency last week after key Euro-Zone data readings, such as the July CPI report and the initial Q2’17 GDP release, meeting or beating expectations. However, the Euro’s gains were significantly obstructed on Friday after an all-around solid July US Nonfarm Payrolls report. EUR/USD, after gaining as much as +1.36% to 1.0910 earlier in the week, barely closed higher by +0.19% at 1.1773.

Curiously, the Euro fell more than any other currency around the US jobs on Friday. Such one-sided price action around an event that doesn’t directly impact the associated currency typically means that extreme positioning is afoot. Indeed, a look at three separate sentiment indicators, including our in-house sentiment reading, the IG Client Sentiment gauge, suggest that the Euro is at a bullish extreme that may impede further gains.

Market positioning would dictate that any weakness in the Euro in the near-term would be of the profit taking variety. Even though positioning has moderated in recent weeks, the Euro long trade remains crowded (relatively speaking). According to the CFTC’s latest COT report, there were 82.6K net-long contracts held by speculators in the futures market for the week ended August 1, just off of thehighest level since the week ended May 3, 2011 (when EUR/USD peaked just below 1.5000).

Another indicator derived from the futures market suggests Euro sentiment is at a bullish extreme. The Daily Sentiment Index (DSI), which aggregates the opinions of active traders in US futures markets, is measured on a scale of 0-100%. High readings (i.e. greater than 90%) suggest that a short-term top is developing or has been made while low readings (i.e. less than 10%) suggest that a short term bottom is developing or has been made. As of Friday, August 4, Euro DSI was 93%, suggesting that we may be near a short-term top.

The big issue moving forward for the Euro seems to be the Euro itself. The reality in FX markets is that with inflation so low, the Euro’s strength may only be tolerated for so long. The ECB’s technical assumption for EUR/USD in 2017 is 1.0800; it closed last week just below $1.1750. As we’ve previously stated, a few more months of a strong Euro, middling energy prices, and persistent underperformance in inflation readings, and it’s easy to envision the ECB taking issue with the market’s hawkish interpretation of the policy adjustments being made.

It seems that the Euro’s best days may be behind it. Given that the upcoming Euro-Zone economic calendar is considerably lighter than in weeks past, and we are in the typically light volume month of August (truly the ‘dog days of summer’), a lack of data catalysts means sentiment and positioning will play a greater role in Euro price action in the coming days.

See our Q3’17 Euro forecast - check out the DailyFX Trading Guides.

--- Written by Christopher Vecchio, Senior Currency Strategist

To contact Christopher, email him at cvecchio@dailyfx.com

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