Euro-Dollar Rate Tipped as Sell after Rally and Economic Recovery Expectations Top Out 

-EUR/USD softens further after Ifo survey misses expectations.
-Draws sellers on faltering risk appetite, ongoing USD rebound.
-Could hit 1.14 Vs USD in coming weeks, rise to 0.94 Vs GBP.
-Risk appetite, stocks and CNH price action all key influences.

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• EUR/USD spot rate at time of writing: 1.1641
• Bank transfer rate (indicative guide): 1.1234-1.1315
• FX specialist providers (indicative guide): 1.1466-1.1536
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The Euro retreated further from a resurgent Dollar on Thursday after the influential Ifo index missed expectations and is once again the subject of bearish wagers after topping out at more-than two year highs in early September and breaking beneath an important technical support level. 

Germany’s Ifo survey revealed a fifth consecutive rise in business optimism about the current economic situation although the increase was smaller than consensus had looked for while the Information and Forschung index that quantifies optimism about the outlook indicated that economic recovery expectations may be close to topping out. 

“When assessing the current state of the economy, one needs to make a distinction between rebound and recovery,” says Carsten Brzeski, chief economist at ING. “This is the stage at which the mechanical rebound due to lifted lockdown measures comes to a halt and at which the more structural face of the Covid-19 crisis surfaces. This is the stage at which companies start to realise that social distancing and local lockdowns are here to stay for a while. Just think of sectors which are experiencing the long-term impact from Covid-19 (aviation, travel, culture) but also sectors for which Covid-19 has become an accelerator of structural transformation (automotive, financials).”

Above: Euro-to-Dollar rate shown at 15-minute intervals with S&P 500 index futures (green line, left axis).

The Ifo index measuring current business conditions rose to 93.4 in September, from 92.5 in August, although the consensus had looked for a n increase to 93.9. “The German economy is stabilizing,” the Ifo Institute said.

The index measuring expectations for the next six months rose from 97.2 to 97.7 and its highest since November 2018, although gains have slowed markedly in the last two months, prompting economists to wonder whether the current outlook is as good as one will get for the foreseeable future. 

Europe’s single currency continued this week’s descent from lofty levels following the report, and even as stock markets crept higher in Europe alongside U.S. equity index futures, although it could have further to fall in the coming months given the Euro-to-Dollar rate has drawn bearish wagers this week for the first time since May. This is after European Central Bank (ECB) protests over its strength and other factors first stopped a three-month long rally and then undermined the exchange rate through September. 

“We believe the break below 1.17 calls time on the EUR uptrend for the time being,” says Jordan Rochester, a strategist at Nomura, who bought EUR/USD at 1.1050 in May but closed the trade this week. 

Above: Euro-to-Dollar rate shown at daily intervals with S&P 500 index futures (green line, left axis).

“Several factors point to continued USD strength and lower risk sentiment due to the reduced chances of US fiscal stimulus. It’s also not clear to us that the market is fully priced for the potential second wave of COVID-19 and the difficulties that firms will face in relying on further loans in a period of lower revenues, especially with waning fiscal and monetary policy effectiveness as time goes on. This is why we add further to our long USD positions here via short EUR/USD in cash,” Rochester adds.

ECB policymakers succeeded in talking the Euro out of a move above 1.20 at the beginning of September, setting it up for weeks of range-trading but a faltering appetite for risk among investors saw the single currency break beneath a cluster of technical supports earlier this week.

Nomura’s Rochester has advocated that clients now bet against the exchange rate is looking for a further retracement back to 1.14 over the coming months. 

The Euro and stock markets it follows have fallen since President Donald Trump further attempted to push two Chinese social media firms out of the U.S. last Friday, while losses may have been aggravated by Washington’s failure to agree additional support for companies and households.

Above: Euro-to-Dollar rate shown at daily intervals with Yuan-to-Dollar rate (green line, left axis).

But this correction is also now being incentivised by recent falls in the Chinese Yuan, which risk reigniting European Central Bank concerns about the trade-weighted exchange rate in the absence of further Euro-to-Dollar declines. 

“Recent verbal intervention from the ECB and the abundance of EUR liquidity continue to paint an opposing picture to the one shown by the RMB,” says Stephen Gallo, European head of FX strategy at BMO Capital Markets. “The PBoC is maintaining the attractiveness of RMB carry despite the recent wobble in global risk assets. This does not mean that the RMB is completely immune to any further weakness in equity markets. But it does suggest that relatively firm RMB rates (and the currency to an extent) are being used as tools by policymakers to lock in flow. Barring a dramatic move lower in global risk appetite, the aforementioned should continue to weigh on EURCNH.”

EUR/USD is more than 20% of Europe’s trade-weighted index (TWI) and its rally had lifted EUR/CNH and another 17% of the TWI sharply until the Yuan eventually pulled  the latter back down from mid-August.

Above: EUR/USD with Euro-to-Yuan (orange line, left axis)and Yuan-to-Dollar rate (green line, left axis).

That EUR/CNH fall is now in question and with it, potentially, the EUR/USD outlook. However, it's the trajectory of stock markets and risk appetite ahead of the U.S. election could have the most influence on the Yuan and Euro ahead. 

It wasn’t until EUR/CNH turned lower that EUR/USD was finally able to probe above 1.20 but the former has since turned higher again amid this week's weakness in the Yuan and could now necessitate further declines in EUR/USD to keep the ECB placated about trade-weighted strength.

Not least of all because since the beginning of September, the Pound-to-Euro rate has fallen more than 3% and exacerbated upward pressure on the trade-weighted Euro through its 15% weighting in the index.

“Long EUR/GBP or short GBP/USD continue to make sense here because of the UK’s low economic mobility, rising COVID-19 trends, falling real yields, furlough scheme ending and Brexit,” says Nomura’s Rochester, who looks for a Pound-to-Euro rate fall from 1.0946 to around 1.0638 in the coming months, which implies more upward pressure on the trade-weighted single currency and potentially argues in favour of further EUR/USD losses.