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EUR/USD Outlook: August Low on Radar as RSI Tracks Downward Trend

EUR/USD Outlook: August Low on Radar as RSI Tracks Downward Trend

David Song,
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EUR/USD Rate Talking Points

EUR/USD appears to be stuck in a narrow range as market participants wait for the Federal Reserve Economic Symposium scheduled for August 27-28, but recent developments in the Relative Strength Index (RSI) warn of a potential shift in market behavior as the indicator establishes a downward trend in August.

EUR/USD Outlook: August Low on Radar as RSI Tracks Downward Trend

EUR/USD is little changed from the start of the week as it struggles to retrace the decline following the Federal Open Market Committee (FOMC) Minutes, and the pullback from the yearly high (1.1966) may turn into a more pronounced correction as the central bank mulls an outcome-based approach versus a calendar-based forward guidance for monetary policy.

It remains to be seen if Fed officials will reveal new information at the economic symposium as the FOMC continues to rule out a yield caps or targets (YCT) policy, but hints of an exit strategy may lead to a material shift in EUR/USD behavior as Chairman Jerome Powell insists that “when the time comes, after the crisis has passed, we will put these emergency tools back in the toolbox.”

On the other hand, the event may indicate more of the same for the next interest rate decision on September 16 as the FOMC appears to be in no rush to scale back the emergency measures, and the macroeconomic environment may keep EUR/USD afloat as the Fed’s balance sheet climbs back above $7 trillion in August.

In turn, current market themes may carry into September as the European Central Bank (ECB) emphasizes that the EUR 1.350 trillion envelope for the pandemic emergency purchase programme (PEPP) “should be considered a ceiling rather than a target,” and the crowing behavior in the US Dollar may also persist in the month ahead as retail traders have been net-short EUR/USD since mid-May.

Image of IG Client Sentiment for EUR/USD rate

The IG Client Sentiment report shows only 37.34% of traders are net-long EUR/USD, with the ratio of traders short to long at 1.68 to 1. The number of traders net-long is 0.36% higher than yesterday and 4.94% higher from last week, while the number of traders net-short is 2.21% higher than yesterday and 1.95% lower from last week.

The rise in net-long position comes as the decline following the FOMC Minutes fails to trigger a test of the monthly low (1.1696), while the recent pickup in net-short interest suggests the tilt in retail sentiment will persist over the remainder of the month even though Chairman Powell and Co. vow to “increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace.”

With that said, recent developments in the RSI could be indicative of a potential exhaustion in the bullish behavior rather than a change in trend, but EUR/USD may continue to give back the advance from the August low (1.1696) as long as the indicator retains the downward trend established earlier this month.

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EUR/USD Rate Daily Chart

Image of EUR/USD rate daily chart

Source: Trading View

  • Keep in mind, a ‘golden cross’ materialized in EUR/USD towards the end of June as the 50-Day SMA (1.1554) crossed above the 200-Day SMA (1.1153), with the moving averages extending the positive slopes into the second half of the year.
  • At the same time, a bull flag formation panned out following the failed attempt to close below the 1.1190 (38.2% retracement) to 1.1220 (78.6% expansion) region in July, with the Relative Strength Index (RSI) helping to validate the continuation pattern as the oscillator bounced along trendline support to preserve the upward trend from March.
  • However, the EUR/USD rally appears to have stalled following the failed attempt to break/close above the 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion) region, with the RSI highlighting a similar dynamic as it slipped below 70 to flash a textbook sell signal.
  • Recent developments in the RSI warn of a potential shift in EUR/USD behavior as the indicator snaps the bullish formation from earlier, with the exchange rate struggling to push back above the Fibonacci overlap around 1.1810 (61.8% retracement) to 1.1850 (100% expansion) as the oscillator establishes a downward trend in August.
  • In turn, the 1.1670 (50% retracement) to 1.1710 (61.8% retracement) region sits on the radar as it lines up with the August low (1.1696), but a break of the monthly range opens up the 1.1600 (61.8% expansion) to 1.1640 (23.6% expansion) area, with the next region of interest coming in around 1.1510 (38.2% expansion) to 1.1520 (23.6% expansion).
  • Looking ahead, will need to see the RSI break out of the newly established downward trend to bring the topside targets back on the radar for EUR/USD.
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--- Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong

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