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EUR/USD Rate Outlook Hinges on ECB Interest Rate Decision

EUR/USD Rate Outlook Hinges on ECB Interest Rate Decision

David Song,
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EUR/USD Rate Talking Points

EUR/USD continues to pullback from the yearly high (1.2011) following the kneejerk reaction to the US Non-Farm Payrolls (NFP) report, but the European Central Bank (ECB) interest rate decision on September 10 may influence the exchange rate if the Governing Council tames speculation for additional monetary support.

EUR/USD Rate Outlook Hinges on ECB Interest Rate Decision

EUR/USD approaches the monthly low (1.1781) as ECB Chief Economist Philip Lane warns that the Euro’s “repricing in recent weeks” may hamper the central bank from achieving its inflation mandate, and the Governing Council may continue to endorse a dovish forward guidance as the central bank stands “ready to adjust all of its instruments, as appropriate, to ensure that inflation moved towards its aim in a sustained manner.”

However, it seems as though President Christine Lagarde and Co. are in no rush to deploy more unconventional measures as the European Union (EU) plans to make the EUR 750B Recovery Fund available from 2021 to 2023, and the updated staff projections may indicate a wait-and-see approach for monetary policy as the account of the July meeting emphasizes that the EUR 1.350 trillion envelope for the pandemic emergency purchase programme (PEPP) “should be considered a ceiling rather than a target.”

In turn, the ECB may stick to the same script as board member Isabel Schnabel insists that “there is no reason to adjust the monetary policy stance” while the Euro Area operates near the baseline scenario, and more of the same from the Governing Council may prop up EUR/USD as the Federal Reserve appears to be on track to utilize its emergency tools throughout the remainder of the year.

Until then, EUR/USD may remain under pressure as the Relative Strength Index (RSI) extends the downward trend carried over from the end of July, but the recent weakness may prove to be an exhaustion in the bullish behavior rather than a change in trend as the exchange rate trades to fresh yearly high (0.6789) in September.

In fact, current market trends may continue to influence EUR/USD as the crowding behavior in the US Dollar carries into September, with retail traders net-short the pair since mid-May.

Image of IG Client Sentiment for EUR/USD rate

The IG Client Sentiment report shows 43.83% of traders are net-long EUR/USD, with the ratio of traders short to long at 1.28 to 1. The number of traders net-long is 17.42% higher than yesterday and 46.26% higher from last week, while the number of traders net-short is 4.51% higher than yesterday and 10.11% lower from last week.

The rise in net-long position has helped to alleviate the tilt in retail sentiment as only 41.63% of traders were net-long EUR/USD last week, but the recent pick up in net-short interest suggests the crowding behavior will persist even though the Federal Reserve’s balance sheet climbs back above $7 trillion in August.

With that said, EUR/USD may face a larger pullback ahead of the ECB meeting as the RSI continues to track a downward trend, but current market trends may keep the exchange rate afloat as it tags a fresh 2020 high (1.2011) in September.

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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 (1.1670) crossed above the 200-Day SMA (1.1191), 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 stalled following the failed attempt to 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.
  • A similar scenario appears to have materialized in September as EUR/USD approaches the approaches the monthly low (1.1781) after staging another failed attempt to close above the 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion) region.
  • EUR/USD may face a larger pullback as the RSI reverses from trendline resistance to preserve the bearish formation carried over from the end of July, with a closing price below the 1.1810 (61.8% retracement) to 1.1850 (100% expansion) region opening up the Fibonacci overlap around 1.1670 (50% retracement) to 1.1710 (61.8% retracement), which lines up with the August low (1.1696).
  • Nevertheless, future developments in the RSI may help to validate a near-term breakout in EUR/USD once the indicator takes out the downward trend, with a move above 70 likely to be accompanied by a further appreciation in the exchange rate like the behavior seen in July.
  • Need a close above the 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion) region to bring the May 2018 high (1.1996) on the radar, with the next area of interest coming in around 1.2080 (78.6% retracement) to 1.2140 (50% retracement).
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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.