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The Euro-to-Dollar Rate is a Trade War and Brexit Story, Analyst Says 

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- EUR/USD rises on outlook for Brexit, U.S.-China trade talks.

- Global factors are main drivers of the single currency for now.

- MUFG tips more gains if U.S.-China and Brexit talks pan out.

- Charts show EUR breaking out of channel, in a bullish move.

The Euro-to-Dollar rate is increasingly buffeted by political factors and will in the weeks ahead take most of its cues from developments on Brexit and the U.S.-China trade conflict, according to analysts at MUFG

The pair, which was trading around 1.105 Friday, has risen more than half a percent this week and broken out of a long-term descending trend channel. The gains are partly attributed to a potential breakthrough in the Brexit saga and optimism over U.S-China trade relations. The change in the Brexit ‘mood music’ came following a positive meeting between the two prime ministers of the UK and Ireland after which the Irish leader Leo Varadkar said he now saw a “pathway” for a possible Brexit deal. 

Varadkar's statement suggests a major shift in stance from Ireland's previous skepticism regarding UK proposals. The Brexit news, along with the U.S.-China developments, have driven Sterling higher but also helped support the Euro. We know this because the Pound surged higher against the Dollar by about 250 pips, more than it did versus the Euro, where the gain was only 180 pips. 

The European economy is significantly exposed to a potential ‘no-deal’ outcome, and it's arguably been the biggest victim of the U.S.-China trade fallout, which means both are important to the outlook.

“EUR direction, for now, will be much more dependent on the two external variables – developments in US-China trade negotiations and developments in Brexit,” says MUFG's Lee Hardman. “The latter of course since yesterday is much more EUR supportive and points to upside risks over the short-term that could be reinforced by progress in Washington talks.”

Above: Euro-to-Dollar rate shown at daily intervals.

It's not just a Brexiting UK that made progress this week as the latest round of U.S.-China trade talks also look set to produce a deal that could put hostilities on ice for at y least a short period. The trade war has seen Eurozone growth fall substantially and helped put Germany on the doorstep of a recession, although it's also wounded the whole global economy.  

“The threat of an ongoing global economic slowdown has kept EURUSD on its slow downtrend,” says Daniel Trum, an strategist at UBS Global Wealth Management. "Depending on the outcome of the US-China trade negotiations on Thursday and Friday this week, EURUSD could also be buffeted by political factors. We expect EURUSD to stabilize around 1.09 at the end of this year." 

A breakthrough in trade negotiations, therefore, would improve the outlook for the Eurozone economy and thereby support the Euro. The U.S. Dollar, on the other hand, has been acting of late more like a safe-haven currency, which gains when global growth declines. because it is seen as a relatively safe high yielding bet, and due to its status as the world’s reserve currency.

The analysis may sound topsy-turvy but this explains why the Euro stands to gain more from a U.S.-China trade pact than the Dollar. Expectations of what might come out of U.S.-China trade talks which kicked off on Thursday have see-sawed from optimism to pessimism to optimism again. Experts are now saying the two superpowers are quite open to doing a small deal. 

“The chances of a small deal are quite high,” says Dennis Yang, a professor at Darden School of Business, a part of Virginia State University. “This is probably Trump’s last chance to reach an agreement before the up-and-coming 2020 elections. On the U.S. side the clock is ticking, and pending tariffs will hurt consumers, and are another factor that could push the U.S. economy into recession. And on the Chinese side the pending tariffs will hurt Chinese companies more than earlier tariffs."

Above: Euro-to-Dollar rate shown at daily intervals, with technical indicators overlayed.

Trade talks are not the only driver of the pair, also important is the outlook for monetary policy in the region. The Euro gained this week partly due to signs the European Central Bank (ECB) is running out of resources to provide liquidity to the Eurozone economy. Whilst this may sound negative for the Euro it is actually positive, since central bank stimulus reduces the interest rates and increases liquidity. The first detracts from foreign capital inflows and the second dilutes the value of the local currency. 

“The market is beginning to realise that the ECB is approaching the end of its interest rate policy options, “ says Ulrich Leuchtmann, a strategist at Commerzbank. “At the same time, the Fed is likely to act more aggressively in the short term than the market expects and will remain under the control of the White House in the medium term. That means that on two fronts things are looking up for a recovery in EUR-USD.”  

From a technical standpoint, the pair has now broken above its descending channel which is a strongly bullish turn of events. The pair has done this on prior occasions, however, such as in August, but at that time early hopes ended in dismay as the exchange rate capitulated back inside the range and then fell to new yearly lows.  

"EUR/USD has at last taken out the four month downtrend and given that the market has recently turned from the base of the weekly channel at 1.0892 we view the market as a base. We look for recovery to initially the mid September high at 1.1110. A close above here would trigger another leg higher to the 200 day ma at 1.1220," says Karen Jones, head of technical analysis at Commerzbank. "The critical resistance to overcome it the top of the one year channel at 1.1303 and the 200 week ma at 1.1354."

 

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