Tactical Play: Fade EUR/USD Exchange Rate Strength

The Euro has pushed fresh multi-month highs against the US Dollar on global foreign exchange markets as traders continue to anticipate pro-Euro policies will be introduced at the European Central Bank in coming months.

The underlying fundamentals justifying the expectations for a more confident central bank are increased political stability and a fast-improving economy.

But a new source of strength for the shared-currency has emerged - Angela Merkel.

Angela Merkel told a group of school children that the Euro was “too weak” and the currency ran higher as a result.

The move took EUR/USD half a percent off of both Sterling and the Dollar.

“That marks a new $1.12-plus 6 month peak for the Euro-Dollar, and a fresh 7 and a half week high against the Pound,” points out Connor Campbell, Financial Analyst with Spreadex.

With German elections due in the Autumn we would expect German politicians to become more vocal in their long-held opposition to the ECB's policy of holding interest rates at record lows which in turn keeps the Euro supressed.

While the ECB is fiercely independent it would still be hard to imagine that vociferous opposition to their policies by Germany wouldn't influence marginal calls in the decision-making process.

Fade the Euro’s Rally

On momentum alone we would expect the Euro to extend its gains; who is brave enough to fight this trend?

“50DMA looks on track to cut 200 DMA to the upside – golden cross pattern – a bullish bias,” says analyst Saktiandi Supaat at Maybank.

The analyst maintains the Euro to Dollar exchange rate (EUR/USD) will likely maintain a bullish bias near-term but warns traders will look to fade the rally as a tactical play.

Supaat says improving fundamental factors in the Eurozone should keep EUR broadly supported while the recent impulsive move higher was driven by US political drama weighing on the Dollar.

Talks of potential Trump impeachment and fear of delay in economic plans (tax reforms and fiscal spending) have kept the USD under pressure.

“We think receding political risks in US should lead to profit-taking on recent excessive gains on the EUR,” says Supaat.

Though bullish momentum on daily chart remains intact Supaat points out that daily stochastic is heading into near-overbought conditions.

“There are also signs of bearish divergence on the MACD. We suspect potential profit-taking on recent gains could come ahead of 1.1230 – 1.1250 resistance."

At the time of writing the market is at 1.1242, so if the analyst is right we could see further upside but the gains could soon be tested with the potential for consolidation or a pullback likely.

Note that such selling pressure would feed into the EUR/GBP exchange rate which could allow the chance for Pound Sterling to recover some lost ground.

“The EURUSD rally now stands at a critical junction with the pair facing a key technical resistance at the 1.1281 level left there from the massive reversal after the ECB press conference last November. The fundamental conditions have improved markedly since then and the pair looks ready to mount a fresh challenge on those highs as well the 1.1300 figure beyond them, but it may take a bit of consolidation before those targets are breached,” says Boris Schlossberg, Director at BK Asset Management in New York.

Euro Boosted by Consensus-Beating Data

The real driver of foreign exchange markets at present is the Euro which has come into favour with global investors in a big way of late.

The Euro is charging higher again thanks to two sets of impressive Eurozone economic statistics released today.

Data from IHS Markit showed that firms are seeing business expand at its strongest pace in six years, giving rise to expectations for a strong quarter for the Eurozone economy.

The composite PMI for May - a broad-based assessment of the business activity of Eurozone firms - read at 56.8, analysts had forecast a reading of 56.6.

“Capacity is being strained by the strength of demand, with backlogs of work showing one of the largest increases in the past six years. Job creation has surged to the second-highest rate in nearly a decade as firms seek to expand capacity and meet rising demand,” says Chris Williamson, Chief Business Economist at IHS Markit.

Meanwhile, data out from Germany was equally impressive.

The Ifo index rose further from 113.0 to 114.6 (Consensus: 113.1).

This is a record high since the index was started in 1991 after reunification.

Business expectations were up strongly from 105.2 to 106.5.

The current assessment component surged from 121.4 to 123.2 and hence also to its highest level since 1991.

When looking at sectors, especially manufacturing and construction companies became again more optimistic.

Both the forward-looking expectations and the current assessment components among manufacturers increased.

The current assessment figure in the construction industry hit another record-high level.

Undoubtedly the news is good for the Eurozone outlook and we would expect the Euro to remain supported. But the chance of such surprises being repeated in future months are unlikely.

“The latest renewed and strong rise in German business sentiment is great news. However, the air for further improvement is increasingly getting thin. While it is impossible to forecast exactly when the peak will be reached, it is clear that we are getting close to it. Repeatedly strong increases in the next few months towards levels seen before reunification (i.e. sentiment among companies in Western Germany) are unlikely in our view,” says Dr. Andreas Rees at UniCredit Research.