“This is a major break, as previously any moves to the 1.14 region have been quickly thwarted.” - Lloyds Bank.
The euro has traded to 1.1616 against the US dollar and recorded an eight month best in doing so.
In mid-week trade we see the shared currency has come off these highs but after the solid run witnessed of late this is to be expected - the market will likely see the pace of upside moves slow ahead of Friday's release of key US employment data.
"EURUSD’s gains to 1.1620 are rather short-lived overnight as the unit hurtles all the way back to the 1.1500 level perhaps as a result of the EU once again reminding investors of the weak state of euro zone fundamentals but more likely due to a partial short covering by USD shorts ahead of Friday’s US April jobs report," note CitiFX in a client briefing released on Wednesday the 4th of May.
The prospects for the euro exchange rate complex remain constructive though.
Eurozone data is improving with Euro area flash GDP growth data for the first quarter surprising to the upside printing above consensus forecasts at 0.6% q/q (0.55% at two decimal places).
This almost doubles its growth rate from Q4 15 and pencils in a new record high since the historical peak in Q1 08.
The moves higher also come amidst rising political criticism against the European Central Bank’s (ECB) negative interest rate policy; widely credited as being behind the euro’s long-term stay below the 1.20 level.
President Mario Draghi reiterated at a conference at the start of May that that there is, “no alternative to continued expansionary policies until the slack in the economy has been reduced.”
Perhaps in the past similar words from the President of the ECB would have triggered euro selling, but with markets are now of the opinion that the central bank has gone as far down the interest rate cutting route as is possible.
Thus, the bet is the ECB will be unable to propagate further exchange rate weakness going forward.
US Dollar Not Helping Itself
Of course this is a binary world and aiding the EUR to USD conversion’s journey higher is a tepid United States economy.
A data heavyweight - the ISM manufacturing index – was published on the first day of the month.
Against the expectations, the index dropped to 50.8 index points in April.
Previously, the final figures on purchasing managers’ indices in the euro area (industry, overall 51.7 index points) came in a tad better than in the provisional version.
The data follows the under-par GDP data release the week earlier. The US economy is still growing, but it is not delivering the positive surprises required to stimulate dollar advances.
“The combination of weak economic data and a dovish Fed is taking its toll on the dollar index and the price action of the last few sessions has taken back to the bottom of its recent range and, in fact, to its lowest closing level in almost sixteen months,” says technical analyst Bill McNamara at brokers Charles Stanley in London.
This weak spell leaves the DXY looking extremely oversold – its 14-day RSI has dropped to a nine-month low of 27% - but the fact that there is still no evidence of divergence implies that there is still scope for further weakness in the near term suggests McNamara.
A 50% retracement of the rally that began in the summer of 2014 implies a downside target of around 90.
As a consequence, the EUR exceeded the 1.15 mark against the Greenback, thus rising to its highest level in 6 1/2 months.
The US Federal Open Market Committee made only minor changes to its policy statement in April, leaving its forward guidance on rates unchanged.
The statement signalled a reduction in concerns over the external environment but acknowledged that, overall, activity and household spending appear to have moderated.
“In our view, the Fed’s steady policy, even as the risk environment and inflation expectations improve, leaves the USD vulnerable versus the funding currencies. We remain long EURUSD targeting a move to 1.16,” says Charlotta Pühringer with BNP Paribas in London.
As we note below, EUR/USD at 1.16 may be too a conservative figure at this stage with 1.19 and above looking likely.
Euro: Bank Earnings Results an Early Warning?
While the euro is seen strengthening against the dollar we must keep in mind that there are signs that the European Central Bank may have to step forward again in the future and take further aggressive actions to stimulate the economy.
Such policy measures are typically held to be negative for the currency as it tends to increase the supply of the said currency into the economy.
More supply = lower prices.
The signs I mention are the most recent earnings reports from the Eurozone’s banking giant.
In Germany, Commerzbank’s quarterly profits more than halved while in Switzerland, UBS printed a significant 64% slump in its Q1 profits besides the lowest transaction revenues ever.
BNP Paribas also announced weaker performance in France, given the challenging economic and business environment.
“The poor performance out of the banking sector is nothing but a reflection of what’s really going on in terms of the real economy. Despite the ultra-accommodative monetary policies and very low, if not negative rates, money is not circulating in the economic tissue; banks have no choice but to suffer the slowdown in money flows,” says Ipek Ozkardeskaya at London Capital Group.
However, the ECB will likely sit back for now as they will want to wait and see whether their most recent interest rate cuts and purchase programme expansion is having a positive effect.
It will take months for the March action to be felt in the wider economy so it could well be business as usual for a few months yet in which time the euro could continue to strengthen.
Can Employment Data Save the Dollar?
The highlight of the week ahead for the euro to dollar exchange rate will be the release of employment data in the US on Friday.
Will we get data that is strong enough to convince the US Federal Reserve that another USD-supportive interest rate is now warranted?
Based on the most recent FOMC statement, the Fed has moved closer to tightening but the chance of a rate rise in June is next to zero because policymakers are still split on the balance of risks.
“Unless stocks climb to record highs, the next 2 payroll reports rise 275K or more, average hourly earnings increase consistently AND consumer spending exceeds 0.5% in April and May, they won't be tightening until September at the earliest,” says Kathy Lien, Director at BK Asset Management in New York.
Nevertheless, positive economic data could help the dollar near-term but it is unlikely that it will offer enough to prompt a sustained recovery in the US dollar.
Lien reminds us that the only thing that matters are expectations - the Fed remains hawkish and yet the dollar falls.
The BoJ and RBNZ are dovish and their currencies rise because investors see this as a confirmation of the impotence of central banks.
“The dollar could remain under pressure until investors are more confident that these and other central banks will resume their intended policy actions,” says Lien.
If this continues we could well see the euro to dollar exchange rate break above key technical barriers and advance to fresh multi-month highs.
Forecasting EUR to USD Above 1.20
The EUR has now cleared important technical resistance in the 1.14-1.1465 region which invites the question - “what next?”
“This is a major break, as previously any moves to the 1.14 region have been quickly thwarted. A move back through 1.1430/1.1380 is the first sign needed to negate the current bullish momentum in place and suggest another false break to the upside,” says Robin Wilkin at Lloyds Bank.
Lloyds have noted in our medium term comments, a break of the 1.1465 region would risk not only a move to the 1.17 region - tested on the back of the Chinese devaluation in August 2015 - but potentially a move towards 1.20-1.23.
According to Lloyds the key resistance levels to watch are 1.17-1.1810 followed by 1.1925/1.20 then 1.2300.