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Euro Forecast: Reversals Test Bulls' Fortitude - Levels in EUR/JPY & EUR/USD Rates

Euro Forecast: Reversals Test Bulls' Fortitude - Levels in EUR/JPY & EUR/USD Rates

Christopher Vecchio, CFA, Senior Strategist
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Euro Forecast Overview:

  • EUR/USD rates have crashed through multiple short-term technical support levels, while EUR/JPY rates are beginning to exhibit similar behavior by falling back into a recent consolidation.
  • A broader reversal in the DXY Index appeared likely at the start of the week, and further gains may only serve to encumber EUR/USD.
  • Per the IG Client Sentiment Index, the Euro still has a bearish bias in the short-term.

Euro Takes a Breather

The Euro climbed steadily with intermittent minor pullbacks throughout November and December, but the recent price action in EUR/USD rates suggests that the Euro may be in trouble in the near-term. With the US Dollar beginning to fulfill its short covering reversal potential (traders closing out short positions, triggering a gain in prices), it may be the case that the Euro, the largest component of the DXY Index at 57.6%, faces challenges in the coming sessions.

The late-Friday news that US President-elect Joe Biden not be able to immediately deliver another tranche of fiscal stimulus provoked another shift in market winds against the Euro, at least vis-à-vis EUR/USD and EUR/JPY rates. For EUR/USD, the news provoked a jump in US real yields, which is typically bullish for the greenback. Meanwhile, reduced stimulus prospects – a reduced trajectory of deficit spending – undercut inflation expectations, dragging down equity markets, spilling into EUR/JPY.

EUR/USD RATE TECHNICAL ANALYSIS: DAILY CHART (January 2020 to January 2021) (CHART 1)

Euro Forecast: Reversals Test Bulls' Fortitude - Levels in EUR/JPY & EUR/USD Rates

EUR/USD rates have crashed through multiple short-term technical support levels that suggest a near-term top may be coming into focus. Throughout November and December 2020, pullbacks never saw a break of the daily 21-EMA. But the pullback in the first week of 2021 now sees EUR/USD rates trading below the daily 21-EMA for the first time since November 23, a warning sign that bullish momentum has been exhausted.

Accordingly, EUR/USD rates are below their daily 5-, 8-, and 13-EMAs, while sitting right at the daily 21-EMA as a ‘final stand’ of sorts for bulls in the near-term. Daily MACD is declining while still in bullish territory, while daily Slow Stochastics have just exited from overbought territory; it should be noted that Slow Stochastics have recently produced a bearish divergence relative to the highs seen in the indicator in December 2020.

A drop below the daily 21-EMA and ultimately the early-December bull flag resistance, now support, at 1.2178, would setup EUR/USD rates for a deeper pullback towards the early-December bull flag support near 1.2059.

IG Client Sentiment Index: EUR/USD Rate Forecast (January 8, 2021) (Chart 2)

Euro Forecast: Reversals Test Bulls' Fortitude - Levels in EUR/JPY & EUR/USD Rates

EUR/USD: Retail trader data shows 40.02% of traders are net-long with the ratio of traders short to long at 1.50 to 1. The number of traders net-long is 17.45% lower than yesterday and 15.22% higher from last week, while the number of traders net-short is 0.39% lower than yesterday and 5.32% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise.

Positioning is more net-short than yesterday but less net-short from last week. The combination of current sentiment and recent changes gives us a further mixed EUR/USD trading bias.

EUR/JPY RATE TECHNICAL ANALYSIS: DAILY CHART (January 2020 to January 2021) (CHART 3)

Euro Forecast: Reversals Test Bulls' Fortitude - Levels in EUR/JPY & EUR/USD Rates

EUR/JPY rates may not be experiencing the same degree of bearish price action as their EUR/USD counterpart, but a bearish key reversal bar forming on Friday suggests that EUR/JPY too may be on its way to a near-term top. EUR/JPY rates are failing to clear the 2020 high, and the attempt to get back above the trendline from the May and September 2020 lows has failed. These are small warning signs that the potential longer-term bullish move may need to wait before further progress.

IG Client Sentiment Index: EUR/JPY Rate Forecast (January 8, 2021) (Chart 4)

Euro Forecast: Reversals Test Bulls' Fortitude - Levels in EUR/JPY & EUR/USD Rates

EUR/JPY: Retail trader data shows 41.61% of traders are net-long with the ratio of traders short to long at 1.40 to 1. The number of traders net-long is 14.39% higher than yesterday and 30.80% higher from last week, while the number of traders net-short is 5.23% lower than yesterday and 21.51% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/JPY prices may continue to rise.

Yet traders are less net-short than yesterday and compared with last week. Recent changes in sentiment warn that the current EUR/JPY price trend may soon reverse lower despite the fact traders remain net-short.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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