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Short EURUSD – Fed vs. ECB Policy Divergence to Fuel Deeper Euro Losses

Short EURUSD – Fed vs. ECB Policy Divergence to Fuel Deeper Euro Losses

Ilya Spivak, Head Strategist, APAC

Selling the Euro against the US Dollar was my top trade for 2014. I reasoned the Fed’s move to taper QE3 asset purchases marked a hawkish policy shift while the ECB looked likely to ramp up stimulus as realized and expected Eurozone inflation readings tumbled. This made for clear-cut policy divergence that promised to shift the yield spread in favor of the greenback, pushing EURUSD downward. The trade worked as expected. Prices found a top at the upper boundary of the multi-year down trend guiding the pair lower since April 2008 and turned downward.

More of the same is likely in 2015. While speculation about the timing of the Fed’s first post-QE interest rate hike will make for volatility, the overall trajectory of FOMC policy seems firmly pointed toward tightening. Meanwhile, a medley of new ECB stimulus measures unveiled in 2014 is floundering, with the central bank’s balance sheet broadly flat since October. Not surprisingly, ECB officials have taken to hinting the onset of “sovereign QE” – the purchase of government bonds with “printed” money – possibly as soon as the first quarter.

Taken together, this is likely to see the rates spread shift even more dramatically in the Dollar’s favor and keep EURUSD firmly under pressure. Prices are flirting with support at trend line support set from June 2010, with a break below this and the 38.2% Fibonacci expansion at 1.2316 exposing the next major downside objective at 1.2140 (50% Fib).

Short EURUSD – Fed vs. ECB Policy Divergence to Fuel Deeper Euro Losses

Chart Created by Ilya Spivak using FXCM’s Trading Station

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