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EUR/USD Rate Trades in Defined Range Despite Dovish ECB Guidance

EUR/USD Rate Trades in Defined Range Despite Dovish ECB Guidance

David Song,
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EUR/USD Rate Talking Points

EUR/USD trades in a narrow range after taking out the August low (1.1696), and the exchange rate may continue to consolidate as the European Central Bank (ECB) appears to be in no rush to alter the path for monetary policy.

EUR/USD Rate Trades in Defined Range Despite Dovish ECB Guidance

EUR/USD holds near the monthly low (1.1612) as ECB President Christine Lagarde reiterates a dovish forward guidance and tells European lawmakers that the central bank “continues to stand ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner.”

The prepared remarks from President Lagarde suggest the ECB will continue to support the Euro Area after expanding the Pandemic Emergency Purchase Programme (PEPP) to EUR 1.35 trillion in June as “the recovery remains incomplete, uncertain and uneven.” President Lagarde insists that the Governing Council “will carefully assess all incoming information, including developments in the exchange rate, with regard to its implications for the medium-term inflation outlook,” and a growing number of ECB officials may comment on the Euro as the central bank struggles to achieve its one and only mandate for price stability.

Nevertheless, it seems as though the ECB will stick to the sidelines at its next meeting on October 29 as “the monetary policy measures that we have taken since early March are providing crucial support to the economic recovery and are helping to safeguard medium-term price stability,” and it seems unlikely that the Governing Council will intervene in foreign exchange markets as Vice-President Luis de Guindos warns that “it would be suicidal to enter into any sort of dispute about exchange rates.”

In turn, swings in investor confidence may influence EUR/USD ahead of the ECB meeting as the pullback from the yearly high (1.2011) largely mimics the weakness in global equity prices, and current market trends may carry into October as retail traders have been net-short the pair since mid-May.

Image of IG Client Sentiment for EUR/USD rate

The IG Client Sentiment report shows 44.67% of traders are currently net-long EUR/USD, with the ratio of traders short to long standing at 1.24 to 1. The number of traders net-long is 2.80% higher than yesterday and 0.81% higher from last week, while the number of traders net-short is 2.29% higher than yesterday and 2.83% higher from last week.

The tilt in retail sentiment has abated going into the end of the month as only 39.73% of traders were net-long EUR/USD last week, but the crowding behavior looks poised to persist in October even though the Fed’s balance sheet widens for the second week to reach its highest level since June.

With that said, the pullback from the yearly high (1.2011) may prove to be an exhaustion in the bullish price action rather than a change in trend as it largely mimics the correction in global equity prices, but EUR/USD may trade within a defined range as long as the Relative Strength Index (RSI) tracks the downward trend carried over from the end of July.

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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 (1.1792) crossed above the 200-Day SMA (1.1240), with the moving averages still tracking the positive slopes from earlier this 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 ultimately break trendline support.
  • A similar scenario materialized in September even though EUR/USD traded to a fresh yearly high (1.2011) at the start of the month, with the exchange rate taking out the August low (1.1696) after staging another failed attempt to close above the 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion) region.
  • EUR/USD appears to be stuck in a narrow range as it snaps the series of lower highs and lows from the previous week, and the exchange rate may continue to consolidate following the failed attempts to break/close below the 1.1600 (61.8% expansion) to 1.1640 (23.6% expansion) region as the RSI appears to be reversing course ahead of oversold territory.
  • Will keep a close eye on the RSI as it continues to track the downward trend carried over from the end of July, but a break of trendline resistance may offer a bullish signal as the indicator fails to reflect the extreme reading seen in February.
  • Need a close above the Fibonacci overlap around 1.1670 (50% retracement) to 1.1710 (61.8% retracement) to bring the 1.1810 (61.8% retracement) to 1.1850 (100% expansion) region back on the radar, with the next area of interest coming in around 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion).
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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.