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Euro Forecast: EUR/USD Rate Rally Eyes January High

Euro Forecast: EUR/USD Rate Rally Eyes January High

David Song, Strategist

EUR/USD Rate Talking Points

EUR/USD climbs to a fresh monthly high (1.2238) following the semi-annual testimony with Federal Reserve Chairman Jerome Powell, and the decline from the January high (1.2350) appears to have been a correction in the broader trend rather than a change in behavior as key market themes remain in place.

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EUR/USD Rate Pullback Emerges Ahead of Account of ECB Meeting

EUR/USD extends the advance from the start of the week on the back of US Dollar weakness, with the commodity bloc currencies trading to fresh 2021 highs against the Greenback, and the Euro may exhibit a similar behavior as the exchange rate breaks out of the descending channel from earlier this year.

It seems as though swings in risk appetite will continue to sway EUR/USD as the reserve currency still reflects an inverse relationship with investor confidence, and the exchange rate may continue to appreciate ahead of the next European Central Bank (ECB) meeting on March 11 as major central banks rely on their non-standard tools to achieve their policy targets.

A recent speech by ECB Chief Economist Philip Lane suggests the Governing Council will retain the current course for monetary policy as “the central bank is committed to recalibrating its underlying policy instruments if it detects any threat to the favourability of financing conditions,” with the board member going onto say that “we will purchase flexibly according to market conditions and with a view to preventing a tightening of financing conditions that is inconsistent with countering the downward impact of the pandemic on the projected path of inflation.

As a result, the ECB may continue to layout a dovish forward guidance as Lane insists that the central bank “will need to continue providing ample monetary accommodation for an extended period, even after the disinflationary pressures caused by the pandemic have been sufficiently offset,” but the Governing Council appears to be in no rush to deploy more unconventional measures as President Christine Lagarde emphasizes that “our preferred tool is the pandemic emergency purchase programme (PPEP).

In turn, EUR/USDmay continue to retrace the decline from the January high (1.2350) as the ECB adopts a wait-and-see approach after expanding the PPEP by EUR 500B at its last meeting for 2020, but the recent shift in retail sentiment looks poised to persist as the crowding behavior from the previous year resurfaces.

Image of IG Client Sentiment for EUR/USD rate

The IG Client Sentiment report shows 40.22% of traders are currently net-long EUR/USD, with the ratio of traders short to long standing at 1.49 to 1.

The number of traders net-long is 15.61% lower than yesterday and 25.04% lower from last week, while the number of traders net-short is 0.53% lower than yesterday and 8.48% higher from last week. The decline in net-long position could be a function of profit-taking behavior as EUR/USD trades to a fresh monthly high (1.2238), while the rise in net-short interest has spurred a largely tilt in retail sentiment as 47.04% of traders were net-long the pair during the previous week.

With that said, the decline from the January high (1.2350) may turn out to be a correction in the broader trend rather than a change in EUR/USD behavior as the exchange rate breaks out of the descending channel from earlier this year, and the Relative Strength Index (RSI) highlights a similar dynamic as the oscillator clears the downward trend from December.

EUR/USD Rate Daily Chart

Image of EUR/USD rate daily chart

Source: Trading View

  • Keep in mind, the EUR/USDcorrection from the September high (1.2011) proved to be an exhaustion in the bullish price action rather than a change in trend following the string of failed attempts to close below the 1.1600 (61.8% expansion) to 1.1640 (23.6% expansion) region, with the Relative Strength Index (RSI) reflecting a similar dynamic as the oscillator broke out of the downward trend to recover from its lowest readings since March.
  • The break/close above the 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion) region pushed EUR/USD to a fresh yearly highs throughout December, with the exchange rate taking out the 2020 high (1.2310) during the first week of January.
  • However, EUR/USD snapped the opening range for 2021 following the failed attempt to test the April 2018 high (1.2414), with the exchange rate trading below the 50-Day SMA (1.2153) for the first time since November.
  • It seems as though the decline from the January high (1.2350) will turn out to be a correction in the broader trend rather than a change in EUR/USD behavior as the exchange rate breaks out of the descending channel from earlier this year, with the move back above the (1.2153) pushing the exchange rate to fresh monthly highs.
  • Need a break/close above the Fibonacci overlap around 1.2220 (38.2% expansion) to 1.2260 (161.8% expansion) to bring the 1.2320 (23.6% retracement) region on the radar, with the next area of interest coming in around 1.2370 (61.8% expansion).
  • Will keep a close eye on the RSI as it approaches overbought territory, with a move above 70 in the oscillator likely to be accompanied by a further appreciation in EUR/USD like the behavior seen in 2020.

--- 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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