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Time to Bet Against the Euro-to-Dollar Rate say Strategists Looking for a Short-term Pullback

- EUR looking overbought, can extend lower
- "We have recommended a short EUR/USD trade" - MUFG
- "Expect EUR/USD to retrace from current levels" - Nordea Markets
- "Expect FX investors to continue looking to 'buy the dip'" - BMO Capital

Bet against the EURUSD

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  • EUR/USD spot rate at time of writing: 1.1781
  • Bank transfer rates (indicative guide): 1.1370-1.1450
  • FX specialist provider rates (indicative guide): 1.1620-1.1670
  • More on getting better rates here

There has been a noticeable increase in foreign exchange strategists at the world's major financial institutions and investment banks looking for a fall in the Euro-Dollar exchange rate over the short-term, although most still see weakness as ultimately short-lived in duration.

The calls comes after a sharp multi-week rally in the exchange rate appears to have stalled just above 1.19, and a retracement back to 1.1750 has since transpired with data suggesting the trade had become overcrowded and increasingly susceptible to any fundamental setbacks.

"The euro neared one-week lows against the data-boosted greenback. The euro’s surge to May 2018 highs last week suffered a setback in stronger than expected U.S. hiring last month. America’s payrolls report, while volatile, suggested the labor market was firing on more cylinders than it had recently been given credit," notes Joe Manimbo, Senior FX Analyst at Western Union.

The question is whether this pullback can extend further or a relentless rally by the Euro is not done.

A key catalyst for many foreign exchange strategists to call further declines in the Euro lies with the incredibly high number of bets that have built up in the market looking to catch the Euro-to-Dollar exchange rate's rally. When positioning reaches extremes it is often a good indication that a rebalancing is due, in this instance it would entail closing 'long' bets in the Euro which would prompt a decline in EUR/USD.

"EUR longs continued to surge and have now reached fresh highs. While the EUR’s fundamentals have improved in recent months on the back of the EU’s Recovery Fund and on the strength on ECB policy objectives, it is possible the trend is becoming over-extended," says Jane Foley, Senior FX Strategist at Rabobank.

Positioning data

"EUR/USD is back below the 1.1800 handle for now but price action remains within recent ranges. Immediate support is around the 1.1730 area while resistance at 1.1930. EUR/USD has appreciated over 8% since mid-May. Positioning data shows that this is the largest accumulation of EUR longs since the dataset began. Given positioning and the extent of the move, expect some pullback in EUR/USD near term," says Bipan Rai, North America Head of FX Strategy at CIBC.

Calling a reversal in a popular trend is fraught with difficulty, but the recent setback is being judged by some foreign exchange analysts to be significant enough to boost confidence that a more discernible correction lower is due to transpire.

"We have recommended a short EUR/USD trade idea to reflect potential downside risks for EUR which is overdue a correction lower. It is not without risks though given it is not yet clear cut that the relentless USD sell off has run its course ahead of Jackson Hole later this month," says Lee Hardman, Currency Analyst at MUFG.

EURUSD forecasts

For Andreas Steno Larsen, FX Strategist at Nordea Markets, the catalyst to a decline in the EUR/USD exchange rate lies with the U.S. Dollar side of the equation, where a shortage of USD liquidity is due to become a factor once more.

"The U.S. Treasury still expects to “out-issue” the Fed with a USD 947bn Q3 target, which could lead to continued withdrawal of USD liquidity depending on the Treasury Cash Balance at the Federal Reserve. The US Treasury expects a quarter-end cash balance at USD 800bn, which is the exact same forecast as for Q2 and we all know how that ended up (USD 1800bn almost)," says Larsen.

The borrowing needs of the U.S. government are set to keep growing as President Donald Trump seeks to increase political support via increased spending ahead of the November election; all the while the Federal Reserve's policy on buying up government bonds remains broadly static suggesting increased demands on dollar liquidity.

Trump said on Monday he’s "very seriously" considering a capital gains tax cut, a move he decided against last September after saying it wouldn’t do enough to help the middle class.

"We’re looking at also considering a capital gains tax cut, which would create a lot more jobs,” Trump said Monday at a White House news conference.

The move comes following the President's decision over the weekend to authorise an extra $400 in weekly unemployment insurance benefits, a potential financial lifeline for the nation's 16.3 million jobless workers.

U.S. fiscal policy appears headed in a direction that suggests more borrowing and demand for dollars, which will aid EUR/USD lower says Nordea's Larsen.

"The withdrawal of USD liquidity (even if it has clearly abated in recent weeks) is a reason to expect EUR/USD to retrace from current levels as the hot money long EUR vs. USD positioning is already stretched at 21.1% of net open interest. We have only had 12 weeks of larger net long positioning on CFTC data over the past decade," says Larsen.

Nordea Markets this week went short on EUR/USD, with a target viewed at 1.1430.

EURUSD daily chart showing stalled rally

Above: Daily EUR/USD chart

However, any declines in the Euro are expected to be shallow and other strategists prefer to look for any weakness as providing opportunities to re-enter bets for further gains, particularly as overbought conditions will have settled and the extreme positioning in the exchange rate will have faded at this point.

CIBC Capital Markets see opportunities to reload on EUR/USD on a retracement back to 1.16.

"We would expect FX investors to continue looking to 'buy the dip' in the pair, with the 1.1700 area likely to be decent short-term support. We don't think price action will turn ugly for EUR longs until a breach of 1.1650 on the downside occurs," says Stephen Gallo, European Head of FX Strategy at BMO Capital Markets.

From a technical perspective, the retracement can go back to just below 1.17 says Robin Wilkin, a multi-asset strategist at Lloyds Bank:

"The bull run stalled in the 1.19-1.20 region and prices are now in correction phase, unwinding divergence in the momentum studies. As such, we remain biased for a broader choppy correction, ideally back to the 1.1690 region, while a break there would open the potential for 1.1600-1.1550 before returning to the trend."


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