EUR/USD: Selling Rallies a Preferred Strategy for Traders for Rest of Summer 2018

- U.S. Dollar enjoying "a tailwind just too hard to ignore"

- EUR/USD a sell on rallies with Credit Suisse, 1.15 liable to break

- Bank of America upgrade US Dollar forecasts

Foreign exchange strategy

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Foreign exchange strategists are warning the Euro will likely remain under pressure against the U.S. Dollar over coming weeks, despite the easing of political risks in the Eurozone.

The EUR/USD has found support over recent days as markets gradually cancelled out a premium on owning Euros due to fears for the future stability of Germany's coalition government over internal differences concerning immigration policy.

We believe news that Angela Merkel has agreed a fix with her CSU partners will help keep the Euro supported in the near-term with the news going some way in ensuring the base just above the 1.15 level remains a firm layer of support for the exchange rate.

A more supportive political environment in Germany has been welcomed by some strategists who believe it should provide some underpinning for the single-currency, but we are warned there are risks to watch elsewhere in the Eurozone, while the future of the U.S. Dollar's bull-run, which has been the dominant feature of global markets since mid-April, remains central to the EUR/USD outlook.

"German political risk should now fade into the background as a downside risk for the Euro in the near-term. It supports our view that Italian political developments will continue to pose the main downside risks for the Euro in the year ahead," says Lee Hardman at MUFG in London.

Italy will not adopt measures to narrow the budget deficit this year, as requested by the European Commission, and is also ready to increase next year’s deficit target, new Economy Minister Giovanni Tria said on Tuesday.

The guidance maintains a confrontational approach adopted by Italy towards the European Union and Eurozone which could well guarantee a steady flow of political uncertainty into Euro prices for the remainder of the year, which might keep advances in the single-currency capped.

"Ongoing sensitivity to politics suggests we should not change our 'sell rallies' EUR/USD view for the summer ahead of the Italian budget focal point that's likely in September. We note that each corrective rally fails at a lower point than the previous one, which adds to the odds that key support at 2018 lows around 1.1500 breaks going forward," says Shahab Jalinoos at Credit Suisse.

The EUR/USD exchange rate put in a strong rally on the final day of June with the market closing at 1.1683 having been as low as 1.1558 earlier in the day.

The recovery from this level is significant as it confirms the existence of a solid level of support in the 1.15-1.1550 area below which the market appears reluctant to move.

EUR to USD chart

Therefore, we would expect any weakness in the coming week to find support at these levels, at least for the near-term. The risk being flagged by Jalinoos however is that it is simply a matter of time before support at 1.15-1.1550 breaks.

"Weakness in European equities and concerns over European exports linked to trade war fears only add to the sense of angst. We recognise however that that at least euro area data surprises are now printing positively, which gives long-term EUR bulls some justification to hope for better times down the line if political anxieties eventually subside. We suspect that without this development, EUR/USD would already have broken below 1.1500," adds Jalinoos.

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The Dollar will Decide Where EUR/USD Goes

The Dollar's medium-term bull run remains a key driver of EUR/USD action and whether or not that run is over remains pivotal to EUR/USD.

"The G10 FX market still looks as if it’s been driven by carry, as opposed to valuation – and in that context, the tailwind for the US Dollar is just too strong to ignore," says Maxime Alimi at AXA Investment Managers.

The US Dollar is likely to rise further against its major rivals in 2018 than previously thought, according to the latest forecasts from strategists at Bank of America Merrill Lynch, who argue the Dollar rally that begun in April will also continue for longer than even they had anticipated.

President Donald Trump's tax reforms and superior levels of economic growth in the US relative to the rest of the world are material factors in Bank of America's new forecasts, which envisage further broad gains for the Dollar including even steeper losses for the Euro-to-Dollar rate and a steady but uninspiring performance from the Pound-to-Dollar rate.

"US data is likely to continue to outpace the rest of G10 as fiscal stimulus boosts the domestic economy. Our out of consensus call on US corporate repatriation still stands. As we outline below, corporate repatriation is well underway with Q1 US balance of payments data showing that US corporates repatriated $175bn of overseas retained earnings," says Kamal Sharma, an FX strategist at Bank of America Merrill Lynch.

Trade war headlines have thrown markets into turmoil, while also obscuring the relatively positive outlook for US growth. This month we push up our core USD forecast. In particular, we have lowered our EUR-USD and raised our USD-CAD forecast profiles," says John Shin, an FX strategy colleague of Sharma's.

The Bank of America team cut their Euro-to-Dollar rate forecasts this week, reflecting an improved outlook for the greenback, and now predict the exchange rate will fall to 1.12 by the end of September before rising only as far as 1.14 in time for year end. These are downgrades from earlier forecasts of 1.17 and 1.20 respectively.

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