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- EUR constrained by German politics, U.S. decision on 'DST' tax.
- German government coalition in danger after SPD leadership vote.
- U.S. Trade Rep to announce response to Frech digital services tax.
- While USD set to remain on front foot amid strong growth figures.
- Yields, improving economic data, trade risks to aid USD this week.
The Euro was little changed for the week on Friday after a last minute rally averted the prospect of a close below the key 1.10 level, but the exchange rate is at risk of fresh declines in the days ahead, according to the charts, while political risks are again also threatening to sink the single currency.
Europe's unified unit was 0.02% lower on Friday, closing around 1.1013 against the Dollar after having recovered from a trip down to 1.0981 in the final noon sesssion of the week. Those earlier losses briefly took the Euro below technical support that spans the distance between 1.0987 and 1.10, which could have invited deeper losses had it closed the day beneath that support.
It's not clear what caused the last minute bump as there were no major economic figures or policy announcements in late noon session, although month-end flows and options expiries were at work on exchange rates amid thin volumes owing to the Thanksgiving holiday in the U.S. and Canada. But some technical analysts at Commerzbank say the Euro could rise in the week ahead but that recent price action has left it vulnerable to a renewed push below 1.10.
"EUR/USD continues to hold over the 1.0989 mid-November low. Whilst it holds, last week’s high at 1.1097 may be revisited, a rise above which would have the 1.1180 October high in its sights. Above 1.1180 will target the 1.1255 one year channel. However the support is looking a little exposed and failure here will trigger another leg lower to the 1.0943 78.6% retracement," says Karen Jones, head of technical analysis at Commerzbank.
Above: Euro-to-Dollar rate shown at hourly intervals.
Jones, who studies trends and momentum on the charts rather than economic fundamentals or political developments, says it's possible the Euro will slip lower toward the 1.0814 level in the weeks ahead, before a sustained recovery is seen. That marks the bottom of a downward sloping trend channel.
However, that trip back down post-2017 lows around 1.09 is not Jones' 'base case'. Rather, she and the Commerzbank team are looking for the single currency to rise steadily in the months ahead after appearing to have set a major 'bottom' on the charts back in October.
"Euro/dollar is probing the 1.09 handle once again as US bond markets re-open with 10yr yields popping back above the 1.77% level. The next major support level comes in at the 1.0970-80s, which is just below where the market sits right now," says Eric Bregar, head of FX strategy at Exchange Bank of Canada.
U.S. bond yields have risen since early October and might rise further in the week ahead if economic data pans out the right way on the other side of the Atlantic. Those yields have proven a powerful draw for the investors toward the Dollar, which has crushed negative-yielding currencies like the Euro, Japanese Yen and Swiss Franc lately.
Julius Baer, a Swiss private bank, wrote last week that the greenback is primed to advance on all of those low-yielding currencies in the coming days and weeks, also citing technical studies of trends and momentum on the charts.
"Combining the negatively yielding currencies and comparing them to the US dollar, we see that an inverted head-and-shoulders pattern is unfolding. As long-term momentum is bottoming, one should expect further gains in the US dollar and possibly a rise to the alltime highs from the year 2002," says Alexis Chassagnade, a technical analysis at the Swiss private bank.
Above: Euro-to-Dollar rate shown at daily intervals.
The Euro: What to Watch
The Euro closed the week on a high Friday after having recovered back above the 1.10 support level late in the noon session, averting a technically bearish daily close below it, but the single currency will enter the new week in a position of vulnerability and with the cards potentially stacked against it.
Germany's Social Democratic Party (SPD) was revealed on Saturday to have voted in favour of the Saskia Esken and Norbert Walter-Borjans leadership duo, shunning party grandees Klara Geywitz and Olaf Scholz in favour of the lesser known pair. And local economists say the decision could be a threat to the stability of the German coalition government of Chancellor Angela Merkel.
"Germany’s centre-left SPD will be led in the future by a little-known left-wing duo who are highly critical of the SPD’s role in Angela Merkel’s government. The vote by SPD members in favour of Saskia Esken/Norbert Walter-Borjans can be seen as a de facto a vote against political stability and against the current “grand coalition," says Holger Schmieding, chief economist at Berenberg. "The result need not spell the end of the government and thus of Angela Merkel’s reign as chancellor. But [removed] the outcome of the SPD membership ballot raises the probability that the SPD will walk out and bring down Merkel within the next six months from 30% to 45%."
Schmieding says a left-wing takeover of the SPD, which governs jointly with the Christian Democratic Union (CDU) as the junior partner in Chancellor Merkel's coalition, will likely come as a negative surprise for markets. That could mean the Euro enters the new week on the back foot.
The Euro's week ahead from the Sunday open will be dominated by economic data and political decisions. IHS Markit will release 'final PMI' numbers for the continent's manufacturing and services industries in November during the morning session and European Central Bank (ECB) chief Christine Lagarde will make an introductory statement at the ECON Hearing of the European Parliament in Brussels at 14:00. And the U.S. is expected to announce its response to the French 'digital services tax'.
Markets will scrutinise Lagarde's statement closely for clarity on what some of her earlier remarks could mean for ECB monetary policy in the initial months of her tenure at the bank. Lagarde took on the post just this month and has said only that the bank will carry out a 'strategic review' of its policies and also "continuously monitor the side effects" of ECB monetary policy. The bank cut one of its interest rates further below zero and telegraphed a resumption of its quantitative easing program in September.
The Office of the U.S. Trade Representative said this week it will publish on Monday, its assessment of the French DST alongside notice of any retaliatory actions to be taken. The White House has previously threatened to impose trade tariffs on imports of goods from Europe in response to the French levy, which the U.S. suggests is in defiance of agreements on dual taxation. It's just the latest in a long line of U.S.-EU trade differences, although an all-out tit-for-tat tariff fight has so-far been avoided.
"Scotiabank Economics research shows that economic risks and trade tensions have inflated the USD significantly since late-2016. Versus the EUR specifically, we estimate the USD’s fundamental fair value currently stands at 1.1330. We expect uncertainty to diminish in the coming 12 months, taking some of the USD’s safety premium away and allowing the EUR to catch up with developments that we think would have otherwise supported a higher valuation for the single currency already," says Sean Osborne, chief FX strategist at Scotiabank.
The Dollar: What to Watch
The Dollar Index closed out the week on a soft footing after a last minute surge by the Euro but is still dominating most rivals, especially its low-yielding counterparts, and some analysts are looking for the relatively strong U.S. economy to keep the Dollar on its front foot in the days ahead.
Dollar price action will be determined on the one hand by developments on the international trade front and on the other hand by economic data that is again setting the world's largest economy apart from many of its rivals.
President Donald Trump signed the Hong Kong Human Rights and Democracy Act last week while the White House was also reported by Reuters to be exploring new ways of restricting Huawei's access to U.S. technology. It's also set to announce on Monday an eagerly-awaited outcome of an investigation into the French digital services tax whic will be sure to garner the market's attention.
The White House has previously threatened to impose trade tariffs on imports of goods from Europe in response to the French levy, which it suggests is in defiance of agreements on dual taxation so the Monday decision is important. Any decision to impose trade tariffs on EU goods in retaliation over the new tax, which will mainly impact U.S. tech companies, would be likely to draw a response from the European Commission but could lift the Dollar because such an event would likely weigh on the Euro.
"The USD is well placed to strengthen further in the near-term. We expect current low FX volatility conditions to continue in the week ahead. It provides a favourable backdrop for higher yielding currencies such as the USD, says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG. "EUR/USD breaking below 1.1000 would be important bullish technical signal for the USD. The SPD leadership election result this weekend could trigger euro selling as well."
U.S. economic data will also draw close scrutiny given how recent figures have discouraged markets from betting too heavily the Federal Reserve (Fed) will cut rates again any time soon. Official data revealed last week the U.S. economy actually picked up steam in the third quarter rather than slowing as many thought that it had and as the Bureau of Economic Analysis intially said it had.
Above: Dollar Index shown at daily intervals.
Meanwhile, the Federal Reserve Bank of Atlanta said last Wednesday its 'GDPNow' estimate of final quarter growth rose to an annualised 1.7% this week, up from just 0.4% for the week ending November 19. Investors will get another dose of figures this week that should give them a better idea of how the economy has performed thus far in the final quarter, with the Institute for Supply Management (ISM) survey of the manufacturing and services industries as well as the November payrolls report all due.
"After bouncing off decade lows last month, the market expects ISM manufacturing to continue recovering towards 50, though the weak regional Fed surveys for November place some downside risk around this estimate. Non-farm payrolls are always important, but the Fed will be watching this particularly closely to assess whether recent easing has started to bear fruit. Consensus is at 190k for employment growth and a flat-line in unemployment at 3.6%," says Daniel Been, head of FX research at ANZ.
Fed Chairman Jerome Powell, as well as other policymakers, has recently said the economy and interest rate settings are “in a good place” and that it would take a “material reassessment” of the outlook to change that view. In other words, anything less than truly dire ISM and payrolls numbers might simply entrench the Dollar's bond yield advantage over lower-yielding currencies like the Euro, Japanese Yen and Swiss Franc.
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