Euro-Dollar Week Ahead Forecast: Vulnerable in Holiday Markets as New Virus, Brexit Loom Large

- EUR/USD enters week vulnerable near to 3-year highs. 
- But should find support near 1.2213, 1.2191 & 1.2175.
- As Brexit goes to wire, new viral strain dents recovery.

Image © European Union - European Parliament, Reproduced Under CC Licensing.

• EUR/USD spot rate at time of writing: 1.2261
• Bank transfer rate (indicative guide): 1.1832-1.1918
• FX specialist providers (indicative guide): 1.2077-1.2175
• More information on FX specialist rates here

The Euro-to-Dollar exchange rate broke to near three-year highs last week but will be vulnerable over the coming days to profit-taking in possibly-illiquid holiday markets, with the Brexit negotiations and escalating coronavirus containment efforts serving as just two potential catalysts for a correction. 

Europe's single currency could be heartened Monday by belated progress among Washington lawmakers who're expected to vote for a $900bn programme of support measures for households and companies on Sunday, which could serve to underpin risk assets like stocks and Euro early this week. 

But the 'stimulus package,' which is barely a third of the size of that seen in March and comes at a time when U.S. cities and states are facing widespread new restrictions on activity, faces stiff competition for investor attention from less positive factors so may not be enough to prevent the Euro correcting lower.

"Some countries have already announced further restrictions into the first half of January (e.g. 10 Jan for Germany outside of a couple of days around Christmas), but if case numbers are still high in early-Jan, then lockdowns will last for longer," says Ned Rumpeltin, European head of FX strategy at TD Securities. "Deal or no deal, a border goes up between the UK and EU on 1 Jan.  We expect the two sides to agree a deal, albeit at the last minute." 

In pole position in the race for attention and a likely weight around the Euro's ankles is the new variant of coronavirus spreading in the UK, which was responsible for a Saturday decision by Prime Minister Boris Johnson to return vast swathes of the economy to 'lockdown' at least until year-end. 

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

The new strain is more infectious than the others and due to some of its mutations there's uncertainty about whether or not it could be guarded against at all using the various coronavirus vaccines now making their way to the market. It's already seen the Netherlands ban flights from the UK after the country detected the virus in a passenger originating from Britain, but would likely be a burden for the Euro and broader markets too if it forces investors to reconsider their assumptions about a 2021 global economic recovery. 

"EURUSD has seen a decisive break above 1.2155 and we maintain our core bullish outlook for a resumption of the uptrend to 1.2355," says David Sneddon, head of technical analysis at Credit Suisse. "Support moves higher to 1.2213 initially, then 1.2191, below which can ease the immediate upside bias." 

Germany, the Netherlands, Austria, Denmark and Italy are among the large European economies who've all imposed new 'lockdown' for the coming weeks in response to increases in infection numbers, although anything that stokes the risk of a prolongation might still come as a blow to sentiment and risk appetite.

In this crucial moment for the
🇪🇺🇬🇧 negotiations, we continue to work hard with @DavidGHFrost and his team.

The EU remains committed to a fair, reciprocal & balanced agreement. We respect the sovereignty of the UK. And we expect the same. (1/2)

— Michel Barnier (@MichelBarnier) December 20, 2020

Investors will be mulling over the implications of the new virus on Monday morning alongside a lack of progress in the Brexit negotiations, which saw a European parliament deadline for a deal go unmet on Sunday and also looks to have prompted a new threat from Prime Minister Boris Johnson to walk away from the talks Friday if a deal is not done by then. The danger for the Euro is that a deal does not materialise until after the clock has been run down, which could lead to losses for both the Euro and Pound.

"We may have become stretched already. The below chart shows the most stretched positioning since 2011 or 2007," says Martin Enlund, chief FX strategist at Nordea Markets. "Whenever a surprising-enough event unfolds, we may thus get big moves against the current consensus and positioning. While it is in the nature of black swans to not be predictable, one can always find some grey swans. For instance, EUR/USD has behaved very much like after the presidential elections of 2000, 2004, 2008 and 2012. And if this history keeps rhyming, the pair may peak – surprisingly early – around New Year’s Eve."

Above: Nordea Markets graph with black line showing bearish wagers against USD rising to decade highs. 

As the Euro and stock markets have risen this year so too have investors' bearish wagers against the U.S. Dollar, but all of these assets may be susceptible this week to profit-taking and exaggerated moves given the impact that a holiday-shortened Christmas week could have on trading volumes. 

"A strong close on the week remains highly likely for spot which will underpin the broader bull tone," says Juan Manuel Herrera, a strategist at Scotiabank in a Friday note. "Trend signals remain bullishly aligned for the EUR across short, medium and longer run DMI oscillators, limiting the EUR’s downside and the USD’s ability to rally significantly. We spot initial support at 1.2225/35. Stronger support stands at 1.2175/85. Minor EUR dips remain a buy." 

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Risk appetite, as reflected by the performance of stock markets, will remain the foremost driver for the Euro in the week ahead but with many parts of the world winding down for the festive season there's little to drive the agenda other than Brexit and coronavirus developments. 

"If topics such as the US stimulus/budget and Brexit can be resolved over coming days, we’d expect this powerful dollar bear trend to continue carrying EUR/USD towards its next major target of 1.25," says Petr Krpata, chief EMEA strategist for currencies and interest rates at ING. "While the timing remains uncertain the eventual agreement should provide a modest boost to GBP. EUR/GBP is to dip below 0.89 and with EUR/USD grinding higher, this suggests GBP/USD pushing to the 1.38 level next week."

Above: Euro-to-Dollar rate shown at weekly intervals alongside U.S. Dollar Index (black line, left axis).