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Euro Forecast: Deeper Setbacks Take Foot in EUR/JPY, EUR/USD Rates

Euro Forecast: Deeper Setbacks Take Foot in EUR/JPY, EUR/USD Rates

Christopher Vecchio, CFA, Senior Strategist
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Euro Forecast Overview:

  • The Italian government is on the verge of failing, while the Dutch government collapsed two months prior to elections. Political risk is weighing down the Euro.
  • EUR/USD has been on worse footing than EUR/JPY as the DXY Index continues its climb.
  • Per the IG Client Sentiment Index, the Euro still has a mixed bias in the short-term.

Euro Dealing with Political Risks

There’s a great deal of attention on the United States right now, if its on the second impeach of outgoing US President Donald Trump, the staggering climb in COVID-19 infections and deaths, or incoming US President-elect Joe Biden’s stimulus plan. All of this attention on the United States has sapped attention span for many market participants, who may not be paying attention to what’s happening across the pond in Europe.

Just this week, the Italian government’s governing coalition appeared to teeter, with former Prime Minister Matteo Renzi pulling his party’s minister from current Prime Minister Giuseppe Conte’s administration. While it’s possible that a rearrangement of the cabinet prevents early elections, which would likely produce a dramatic turnover in government with the rise of Matteo Salvini. To close the week, Dutch Prime Minister Mark Rutte announced that he would dissolve the government two months prior to new elections following a child welfare scandal.

All of the sudden, the Euro, which was a high flyer coming into 2021, is now burdened by the albatross of political risk, even if markets’ collective attention still remains on the United States.

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

Euro Forecast: Deeper Setbacks Take Foot in EUR/JPY, EUR/USD Rates

In the prior Euro forecast update on January 8, it was noted that “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.”

EUR/USD rates are dropping further below their daily 5-, 8-, 13-, and 21-EMA envelope, which is now in bearish sequential order. Daily MACD continues to decline while in bullish territory, while daily Slow Stochastics have fallen into oversold territory, a sign of strong bearish momentum. Losses may not extend that deep, however, if the longer-term bullish perspective (and DXY Index double top) remains valid.

The rising trendline from the May and November 2020 lows comes into focus near 1.1950 through next week, in the midst of a confluence of significant technical levels: 23.6% Fibonacci retracement of the 2019 low/2020 high range at 1.1945; the August and September 2020 highs at 1.1967 and 1.2011, respectively; and the 23.6% Fibonacci retracement of the 2017 low/2018 high range at 1.2033. In aggregate, this major support zone is carved out between 1.1945 and 1.2033. Failure below here would be a significant bearish technical development.

IG Client Sentiment Index: EUR/USD Rate Forecast (January 15, 2021) (Chart 2)

Euro Forecast: Deeper Setbacks Take Foot in EUR/JPY, EUR/USD Rates

EUR/USD: Retail trader data shows 44.68% of traders are net-long with the ratio of traders short to long at 1.24 to 1. The number of traders net-long is 7.51% lower than yesterday and 14.97% higher from last week, while the number of traders net-short is 7.06% lower than yesterday and 5.02% lower 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: Deeper Setbacks Take Foot in EUR/JPY, EUR/USD Rates

EUR/JPY rates have hit the skids in recent days, joining the slide in global equity markets (which EUR/JPY tends to track more closely than EUR/USD). EUR/JPY has dropped below the rising trendline from the October and November 2020 swing lows at the end of the week, and accelerating bearish momentum suggests that a deeper setback may still yet develop. The rising trendline from the May and November 2020 lows comes into focus near 124.70 next week, which overlaps with the 38.2% Fibonacci retracement of the 2014 high/2016 low range at 124.71.

IG Client Sentiment Index: EUR/JPY Rate Forecast (January 15, 2021) (Chart 4)

Euro Forecast: Deeper Setbacks Take Foot in EUR/JPY, EUR/USD Rates

EUR/JPY: Retail trader data shows 42.12% of traders are net-long with the ratio of traders short to long at 1.37 to 1. The number of traders net-long is 13.46% lower than yesterday and 12.90% lower from last week, while the number of traders net-short is 3.89% lower than yesterday and 14.71% lower 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.

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/JPY trading bias.

--- 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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