Euro-Dollar Taps on 1.20 Trapdoor

- EUR/USD at risk of sharper drop on breach of 1.20
- Table turns on EU vs. US growth expectations
- Stabilising yields, position squaring could support EUR

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  • EUR/USD spot at publication: 1.2020
  • Bank transfer rates (indicative guide): 1.16001-1.1680
  • Money transfer specialist rates (indicative): 1.1955
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The Euro is under pressure against a broadly ascending U.S. Dollar, a move aided by soft global equity markets and a view that the U.S. economy is on course to outperform that of the Eurozone in 2021.

We are told by analysts that any break below the psychologically and technically significant level of 1.20 could open the door to a faster move lower, and a potential reset in the Euro-to-Dollar exchange rate's (EUR/USD) short-term range. However, other analysts say that the Dollar is benefiting from a clean out in over ambitious market positioning, and the Dollar's run could soon fade as the rebalancing process completes.

EUR/USD is down a third of a percent to quote just above 1.20 at the time of publication on Tuesday, but a look at the data does show the exchange rate dipped its toes below 1.20 to quote a low at 1.1992 earlier in the day.

Global equity markets are softer on no real news, suggesting that an age-old rule that the Dollar rises when stocks fall is contributing to FX market dynamics.

"The stronger U.S. Dollar has dragged EUR/USD to the key $1.20 handle, whilst GBP/USD extends its decline below $1.39 having been above $1.42 last week," says George Vessey, a foreign exchange analyst at Western Union Business Solutions.

"Bets of a faster economic recovery in the U.S. compared to other economies and expectations of the US Federal Reserve allowing bond yields to rise higher relative to other central banks, is helping the U.S. Dollar climb against its lower yielding peers," adds Vessey.

Euro to Dollar

Above: The last time EUR/USD dropped below 1.20 in 2021 the move proved to be a false breakout.

"This morning and maybe this week, there is no doubt that the momentum is with the dollar and against the euro," says Kit Juckes, a foreign exchange analyst at Société Générale.

Juckes says expectations for a quicker rate of economic growth and inflation in the U.S. are providing a fundamental support for the move.

He notes that in September the consensus forecast for Eurozone GDP growth in 2021 was 2% higher than the consensus for the US (5.7% vs 3.7%).

"Now, the tables are turned and the consensus forecast for the US is 4.9%, 0.7% higher than the Eurozone one," says Juckes.

U.S. growth outperformance is likely to be aided by further fiscal support stemming from the U.S. government which intends to distribute an addition $1.9TRN in giveaways to help fight the economic downturn in the near-future.

However, Juckes says there is a chance that the market is merely cleaning out the extreme positioning it held on the Dollar and Euro entering 2021 - investors had been betting heavily on EUR/USD upside in 2021, but now the trade is being questioned these bets are being unwound.

When a rebalancing of the market's positioning is completed, the Euro could find itself better supported.

"This and the Biden fiscal package priced in and vaccines being distributed in the U.S., while Europe lags and struggles, strikes me as peak pessimism about the economic outlook," says Juckes.

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Global markets have become increasingly attuned to developments in the yield paid on government bonds, with analysts saying that the Dollar is benefiting from the rapid increase in yield being paid on U.S. bonds, particularly those dated with a 10-year maturity.

The rise in yields in turn reflects expectations for strong U.S. growth over coming months, and stronger-than-expected levels of inflation. Therefore bond holders are asking for a higher return on their holdings, reflected in rising bond yields, to hold these assets in a higher inflation environment.

The rise in yields also reflect an expectation that the U.S. Federal Reserve is likely to bring forward the time it cuts back its quantitative easing programme and begins to raise rates again.

The Fed could start to 'taper' its bond purchases under the quantitative easing programme as early as September, says one economist.

This, when contrasted to the European Central Bank's reluctance to consider such moves, provides some potential additional support for the Dollar.

The ECB looks keen to fight back against a rise in Eurozone bond yields, with French central bank governor Villeroy de Galhau saying on Monday that "in so much as this tightening (in financial conditions) is unwarranted, we can and must react against it, starting with an active flexibility of our PEPP purchases."

Should yield rises start to fade, as some economists are suggesting, then the impulse of Dollar buying could fade alongside.

From a technical perspective the 1.20 level is certainly important, with some analysts saying a break below here could usher in faster declines and could reset the EUR/USD exchange rate at lower levels.

"EURUSD remains heavy, with the pivotal 1.2000 level nearing again. A break below could suggest a deeper consolidation back into the 1.1600-1900 zone and thus a more extended neutralisation of the longer-term up-trend that started late last spring and over the summer," says Steen Jakobsen, Chief Investment Officer at Saxo Bank.

Karen Jones, Head of Technical Research at Commerzbank says EUR/USD has eroded the 1.2042 uptrend and focus has dropped to the September high at 1.2014.

"This is now exposed – it guards key short term support, which lies at 1.1945, this is the 23.6% retracement of the move up since March 2020," she says in a note out Tuesday.

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