Will The ECB Warn Against EUR Strength at Jackson Hole?

Aug 16 2017, 1:08 pm

EUR Rises Ahead of Schedule

Over the year so far, the US Dollar (according to the Fed’s measurement) has lost around 7%, seeing EURUSD shoot up to 1.18. Many investment banks and analysts had been calling for EURUSD to reach 1.20 by year end but it now looks as though price is going to hit that level well above schedule.

Although the US Dollar is unlikely to continue its current bearish momentum, and is vulnerable to a reversal, the Euro is likely to continue higher as pension funds and insurance companies begin to increase their EUR currency exposure from current historically low levels.

Hedging Adjustments to Support EUR

In 2014 when the ECB adopted its ultra-loose monetary policy, many investors hedged not only their FX flows but their holdings of EUR denominated assets. If real money players opt to reduce their EUR hedges, this stock of EUR denominated assets should create its own dynamic supporting EUR.

EUR Nature Shifting

The nature of EUR appears to have shifted more into an asset currency, reflected by increasing FX-unhedged inflows into European Monetary Union equities with EUR rallying alongside rising global asset prices. With global growth accelerating and assets prices remaining firm the outlook for further EUR strength looks firm. However, increased EUR strength weighs on the EMU growth and inflation outlook which could push the ECB to lean back against ECB strength.

ECB To Verbally Intervene at Jackson Hole Symposium?

The Jackson Hole Symposium later this month could be the time at which the ECB opts to do this. However, it is important to point out that the current fundamental environment is different to September 2015 when Draghi verbally intervened. At that time, global growth was weakening, commodity prices were declining and capital outflows from China were in danger of forcing an unwanted deleveraging.

Risk Factors to EUR Strength

If the ECB does verbally intervene this time it will be more about buying time than effecting fundamental change in its current policy approach – as outlined by Draghi at the Sintra forum. The element which could provide a real boost for EUR is the EMU developing into a more optimal currency area. If the ECB had refrained from basing its monetary policy on its weakest link at the time (Italy) the increased credit spreads would have caused diverging fiscal and monetary policy in the eurozone, ultimately constraining capital availability within the periphery.

Consequently, the EUR reacted to the fundamentals of the periphery. However, the current prospect of fiscal and banking sector integration indicates that EUR is moving away from periphery fundamentals. The addition of risk elements such as Brexit and the Trump administration suggests that EUR is likely to move more in this direction instead of reverting.  Furthermore, populism among EMU members has increased break-up risk.

Technical Perspective

After breaking out above the 2016 high last week, EUR has since retraced lower to retest the broken level. For now, price is moving in a bullish channel while holding above the (red horizontal line) focus remains on the upside. Indeed, the current correction is forming a classic bull flag formation, suggesting the likelihood of a topside breakout in the near term.

The next key objective will be the 50% retracement from 2014 highs around 1.2163. To the downside, key support comes in around the 1.4594 level where there is a raft of prior highs over 2016 and 2015. This will be a key downside pivot with a break below this level signalling the likelihood of a deeper correction.

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With over 6 years’ experience analysing currency markets, James is now a well-known industry analyst focusing on price action trading and fundamental drivers. Beginning as a private retail trader, James developed a strong interest in understanding the fundamental aspect of the market before pursuing technical trading capabilities which he now uses to identify opportunities over a short-term horizon. Alongside his market experience, James is also IMC certified having achieved the qualification to help further his understanding not only of the markets but the industry as a whole. James has a strong interest in both fundamentals and technicals and uses both forms of analysis in generating and executing trade ideas, with trades generally lasting from a few hours to a few days.