EURUSD: USD Weakness Points To Higher Prices

Posted on
USDWeakness

One of the big stories dominating the markets over the first few trading weeks of the year, is reflation in both Europe and the US. These battling forces have created an interesting environment and investors and traders are split over which side of the pond will prevail after current increases in USD weakness.

 

USD Stalling Despite Fed Hikes

One of the most interesting aspects of the USD’s current performance is that the Dollar is not rallying, despite the Fed being in the middle of a hiking cycle, leading to widening US rate differentials. In the past this dynamic has been firmly USD positive though, the current situation seems more in line with price action over the Fed’s 2004-2006 hiking cycle. During that specific period it was the acute deterioration in the US current account that caused USD weakness, as flows took on more importance than rates. This is potentially the same situation we are seeing now as portfolio inflows to the US, which saw a boom over 2014-2016, have now peaked and have started slowing. Given that US equity and fixed income valuations are at highs for the last century, it is unlikely that there will be much further buying of US assets over the year ahead.

One argument for a stronger US Dollar is the successful implementation of the tax reform achieved at the end of last year. However, although these tax cuts will make it easier for the Fed to continue hiking, the impact on the US Dollar might not be as pronounced if flows are currently more important than rates. The implemented tax cuts will see the USA’s twin deficit widened by a minimum of 2% over the coming years and, as with the basic balance, inflection points have typically coincided with turns in the US Dollar also.

 

Europe On The Rise

However, the European story looks far more encouraging. USD weakness is currently not responding to Fed hiking as policy normalisation has been widely priced in. USD (trade weighted) has appreciated by around 25%, on a cumulative basis, since the tightening cycle began in 2015 while EUR has only strengthened by around 10% since ECB tapering began. This suggests that EUR sensitivity to ECB tightening is likely to be higher, with the prospect of a quicker-than-expected removal of accommodative monetary policy by the ECB. This then leaves the Euro vulnerable to greater upside moves.

Data from the Eurozone continues to highlight a picture of positive momentum, headlined by the European Commission’s economic sentiment indicator (ESI). The ESI hit it’s highest levels in 10 years on the last reading alongside the Business Climate indicator rising to its highest levels since 1985. Indeed, all sectors saw an improvement in sentiment and the country breakdown showed that the strongest increases were in Germany and France. Also of note is the fact that the ESI is now above its long-term average in Greece.

The economy is clearly gaining pace and the consensus call for Eurozone GDP growth of 2.4% now looks firmly achievable this year. However, it is important to note that, inflation still remains a headwind. Although some pipeline inflation is starting to emerge as selling price expectations rose strongly in both the industry and at a weaker level in construction, selling expectations actually fell in services and retails while consumer inflation expectations are weaker also.

The ECB has highlighted that it will not raise rates simply because the economy is performing well but, if current momentum continues, most investors will anticipate a shift in this approach.

 

 

Indeed, the latest COT data shows that institutional positioning in EUR has risen to multi year highs at the beginning of the year as most expect that the ECB is downplaying its intentions for tapering and rate adjustment.

 

Technical Perspective

 

After rallying to test 2017 highs, EURUSD is currently stalled at a potential double top pattern. However, strong support sits just ahead of the pattern neckline at the 1.1718 level (former 2015 high). While this level holds, focus remains on further upside.

 

 

(Visited 34 times, 1 visits today)

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.

START TRADING

or practice on DEMO ACCOUNT

Trading CFDs Involves high risk of loss

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.

© Orbex