4 Reasons why Euro-to-Dollar Rate Weakness Could Fade: Scotiabank

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- EUR/USD Falling towards April Lows

- "no real sense that the market is poised to lean too hard" on EUR/USD

- Call based on charts, bond markets, swap markets and fair value studies

The EUR/USD is trading in the 1.1130s and is falling ever closer to a key landmark level at the April lows at 1.1110 and it could be a matter of time before those lows are eventually touched.

But, according to analysts at Scotiabank downside momentum is lapsing and the pair is unlikely to slide much deeper.

Scotiabank lists four reasons to expect the pair to stall, and possibly even reverse.

1) Technicals

“EUR/USD remains soft but there is no real sense that the market is poised to lean too hard on the key support at 1.1100/10 at the moment,” says Shaun Osborne, a strategist at Scotiabank in Toronto.

Short-term price action is characterised as ‘indecisive’. A number of ‘doji-like’ candles have formed. Dojis are Japanese candlesticks which suggest a market reaching equilibrium or indecision on the part of participants.

The preponderance of neutral signs could be the precursor to a reversal higher.

“The market cannot sustain downside pressure,” says Osborne and Theoret. “This is a potential positive as these collections of signals sometimes imply a generalized stall in the trend ahead of a reversal. Minor resistance is 1.1180/90. Key resistance is 1.1315.”

2) Euro too Cheap

The pair is also very close to its fair value estimate, that is its value based on spreads and relative equity returns, which Scotiabank estimate to be at 1.1202.

3) Bond Markets Moving in Favour of the Euro

Strategists often say EUR/USD is especially sensitive to relative interest rates. Investors tend to favour the currency in the jurisdiction with the higher interest rate so they can earn more from the interest returns when they park their capital.

In the case of EUR/USD, the common way of measuring the difference is to use government bond spreads, which are the difference between Eurozone and U.S. government bond yields. At the moment these are showing that yields are stabilising in favour of the Euro.

“Short-term cash bond spreads have stabilised (Eurozone-US 2Y spreads are holding around -280bps),” says Osborne.

This is probably due to the increasingly pessimistic view of the U.S. economy and rising expectations interest rates there will fall.

Many economists view the U.S. as reaching a cycle peak. Recent concerns about the risk of record high corporate debt in the U.S, voiced by a Federal Reserve (Fed) official, also caught the market by surprise.

4) Demand for Dollars is Stabilising

Scotiabank sees downside for EUR/USD as being limited from here as the cost of Dollar funding - i.e. a barometer for Dollar demand, is levelling off.

Gauging demand for Dollars can be done through the swaps market.

During the financial crisis, when demand for safe-haven Dollars was high the cost of a EUR/USD cross currency basis swap shot to -120 bps at one point.

Recently the cost of Dollar funding rose once again and swaps reached -50 bps but now they have steadied (3m basis at - 17bps) in a sign demand for Dollars has stabilised and, “reducing the dynamic influence of these markets on spot” according to Scotia.

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