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EUR/USD Recovery to Gather Pace as RSI Breaks Out of Downward Trend

EUR/USD Recovery to Gather Pace as RSI Breaks Out of Downward Trend

2020-10-06 05:00:00
David Song, Strategist
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EUR/USD Rate Talking Points

EUR/USD extends the advance from the September low (1.1612) even though European Central Bank (ECB) officials warn of a protracted recovery, and the Relative Strength Index (RSI) indicates a further appreciation in the exchange rate as it breaks out of the downward trend carried over from late July.

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EUR/USD Recovery to Gather Pace as RSI Breaks Out of Downward Trend

The rebound in EUR/USD largely mimics the recovery in global equity prices as the pick up in risk appetite drags on the US Dollar, and a further improvement in investor confidence may prop up the exchange rate as US President Donald Trump tweets “the Stock Market is getting ready to break its all time high.”

Image of US President Donald Trump Tweet

It remains to be seen if EUR/USD will continue to retrace the decline from the 2020 high (1.2011) as the ECB retains a dovish forward guidance, and a growing number of Governing Council officials may show a greater willingness to further insulate the Euro Area as Bundesbank President Jens Weidmann warns that the economic recovery “is in fact becoming flatter.”

Weidmann goes on to say that “the recovery of the German economy is likely to be protracted and to remain incomplete for some time,” but it seems as though the ECB is in no rush to deploy more unconventional tools in 2020 as the Governing Council insists 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 account of the ECB’s September meeting may do little to derail the rebound in EUR/USD as the central bank carries out a wait-and-see approach, and the fresh transcript may indicate more of the same for the next meeting on October 29 especially as Vice-President Luis de Guindosargues that “it would be suicidal to enter into any sort of dispute about exchange rates.

Until then, key market trends may continue to influence EUR/USD as even though President Christine Lagarde and Co. stand ready to adjust all of its instruments,” and the tilt in retail sentiment looks poised to persist in October as 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 only 32.86% of traders are currently net-long EUR/USD, with the ratio of traders short to long at 2.04 to 1. The number of traders net-long is 5.64% lower than yesterday and 22.64% lower from last week, while the number of traders net-short is 13.03% higher than yesterday and 22.78% higher from last week.

The decline in net-long position could be a function of profit-taking behavior as EUR/USD extends the advance from the September low (1.1612), but the rise in net-short interest has spurred a further tilt in retail sentiment as 38.79% of traders were net-long the pair at the start of the month.

With that said, key market themes may continue to influence EUR/USD as the crowding behavior carries into October, and the pullback from the yearly high (1.2011) may prove to be an exhaustion in the bullish trend rather than a change in market behavior as it largely mimics the correction in global equity prices.

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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 (1.1802) crossed above the 200-Day SMA (1.1256), 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.
  • Nevertheless, 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 amid the failed attempt to break/close below the 1.1600 (61.8% expansion) to 1.1640 (23.6% expansion) region, with the RSI highlighting a similar dynamic as it reverses ahead of oversold territory and breaks of the downward trend carried over from the end of July.
  • The move back above the Fibonacci overlap around 1.1670 (50% retracement) to 1.1710 (61.8% retracement) has pushed EUR/USD up against the 1.1810 (61.8% retracement) to 1.1850 (100% expansion) region, 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.

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