Euro-Dollar Week Ahead: Volatility Ahead as Turkish Currency Makes Waves, Risk Appetite Tested

- Volatility ahead on TRY moves and multiple threats to sentiment.
- U.S. fiscal story, virus, China & TRY falls all offer support to USD.
- As TRY recovery calls for lower EUR & losses, higher EUR/USD.

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• EUR/USD spot rate at time of writing: 1.1782
• Bank transfer rate (indicative guide): 1.1371-1.1453
• FX specialist providers (indicative guide): 1.1606-1.1677
• More information on FX specialist rates here

The Euro-to-Dollar exchange rate clocked its seventh weekly gain Friday but will be volatile in the days ahead amid a possible tussle between Turkish authorities and the market as well as various headwinds to risk appetite.

Europe's single currency edged higher last week but pared gains sharply on Friday after a better-than-expected jobs report from the U.S. and as the Turkish Lira lifted off lows seen in a ferocious sell-off during the prior session. 

"Given the huge cross-correlation in reflationary assets these days (including a possible bubble in silver), the risk is growing of a short, sharp correction," says Chris Turner, regional head of research at ING. "There is outside risk that EUR/USD quickly trades down to the 1.1630/50 area – e.g. were US-China tension or continued failure over the Phase IV stimulus to trigger a stock market correction. Yet we expect willing buyers to emerge under 1.17, looking for 1.20."

The Turkish Lira will be an important influence on price action in the single currency this week given that it's one of the primary conduits through which a tussle between Turkish authorities and the market would be played out.

But it won't be the only influence as investors assess on Monday the economic impact of executive orders  from the White House that extend emergency aid support for American households, though at reduced levels, after lawmakers were unable to reach a bipartisan agreement. 

It's not clear if greater clarity over the level of fiscal support offered to the U.S. economy will be enough to sustain a Dollar rebound and keep pressure on EUR/USD although there's also fresh tensions between the U.S. and China that will be at play too. Then there's the charts too.

Above: Euro-to-Dollar rate shown at daily intervals alongside USD/TRY rate (orange line, left axis).

"EUR/USD is struggling very near term at the 1.1915 January 2018 low and last months high at 1.1908. There is now a large divergence of the RSI and we look for a deeper correction lower. Initial support lies 1.1646/36 (a double Fibo) ahead of the March high at 1.1495. Ideally dips lower will be contained by the 3 month uptrend at 1.1488," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank. 

USD/TRY has been rising as market pressure on the Turkish currency has mounted but the exchange rate hasn't been able to rise enough to deliver a matching rally in the more economically important Euro-to-Lira rate without a higher Euro-to-Dollar rate at the same time. 

Mechanically, Lira depreciation is often a source of upside pressure on EUR/USD but there's a rub for everybody in that despite this, the Euro also has a tendency toward sharp losses whenever the Lira is in distress. 

This makes volatility in the Turkish currency a recipe for wild price action in the broader market too, including among major currencies, which has already got parts of a bullish analyst community looking to sell the single currency.

"We are recommending a short EUR/USD trade idea. It is short-term tactical trade to reflect the increasing risk of a correction lower," says Lee Hardman, a currency analyst at MUFG. "The euro underperformed during the lira currency crisis in 2018 which highlights downside risks going forward if history is repeated. At the same time, there is building concern over the renewed spread of COVID-19 in Europe which could take some shine away from the EUR. We are wary though of the risks that the USD could remain under selling pressure ahead of Jackson Hole later this month so have set a tight stop."

Euro losses might be most noteworthy in a Turkish Lira recovery given the recently improved correlation between USD/TRY and EUR/TRY, which implies EUR/USD declines that would leave the single currency looking like a safe-haven rather than the risk currency it's traded as of late. 

Above: Euro-to-Dollar rate shown at daily intervals alongside EUR/TRY rate (orange line, left axis).

Turkish losses will make waves in EUR/USD, other major exchange rates and the Dollar Index just as investors also navigate increasing tensions between the U.S. and China after the White House confirmed bans on some Chinese technology firms Friday, helping to sour risk appetite.

China's threat of retaliation was parried by U.S. Treasury sanctions on 12 Chinese officials reportedly including Hong Kong chief executive Carrie Lam, which are moves that may draw retaliation over the coming days. 

"We lean short in the pair due to USD liquidity, a stretched long in hot money positioning and the smell of roasted Turkey. We enter short EUR/USD with a target of 1.1430 and a S/L at 1.1940 (accordingly we take profit in long EUR/CHF)," says Andreas Steno Larsen, chief FX strategist at Nordea Markets.

The U.S.-China mood has been deteriorating for a while and the outcome of a six-month review into January's 'phase one" phase deal is expected, with the risk being that the U.S. decides to terminate the accord and reimpose tariffs. 

New tariffs and further tensions will heap more pressure on the embattled global economy and could keep risk assets in retreat while lifting the Dollar, although economic data from the U.S. and daily coronavirus statistics from European capitals will also help shape the market's mood. 

"Solid incoming data, including for the US labor market, show a continuing global recovery. More China data and US retail sales next week could solidify this," says Christian Keller, head of economics research at Barclays. "Re-accelerating COVID-19 cases are fueling fears of ‘second waves’, but their economic consequences would likely remain more muted than in Q2, in our view. However, a potential ‘no-deal’ on the US Phase 4 fiscal stimulus and the further intensification in US-China tensions have now grown as threats."

Above: Euro-to-Dollar rate shown at daily intervals alongside EUR/TRY rate (orange line, left axis).