EUR/USD Exchange Rate's Move Lower is Incomplete Warn Forecasters

A break below 1.10 in the EUR to USD conversion is looking increasingly plausible as the move lower enters a sweet-spot.

There are growing signs that the euro to dollar exchange rate may be about to start a more bearish trend.

The euro shed over a percent against the greenback at the start of the week and fell to a three-year low against the Japanese yen, dragged lower by mounting worries about a possible Brexit.

"The U.K. leaving the 28-member bloc seriously increases the risk of other anti-EU movements across the Europe gaining traction and could trigger a domino effect of departures from the political bloc," point out Commonwealth Foreign Exchange.

This echoes a view earlier put forward by researchers at Barclays, but it seems markets are only becoming awake to the fact now.

"Against our expectation, EUR broke below the 1.1060 support resulting  in a sharp drop to a low of 1.1000. The down-move appears incomplete  and another leg lower is likely from here but a sustained move below 1.0990 appears unlikely," says Quek Ser Leang at U.O.B, "Only a move back above 1.1075/80 would indicate that the current downward pressure has eased."

Chris Turner at ING says should the risk environment temporarily stabilise, the next few weeks may emerge as the sweet spot for EUR/USD downside.

"It is possible that we may see some corners of the market overestimate the scale of likely ECB easing at the Mar meeting, while the degree to which markets have dovishly re-priced the Fed’s hiking cycle could also come into question," says Turner. 

Note that the probability of a Fed rate hike in June has ticked up from around 11% to 27% in the past week.

"We may need to see this scenario unfold more materially in order to see a significant EUR/USD move below 1.1000," says Turner.

Our analysis shows that a break below1.10 looks ever more plausible as negative data has started to take its toll on the outlook for the single currency.

German Confidence Data Shows 'Alarming' Dip in Sentiment

Driving the euro exchange rate complex lower on Tuesday was news that business confidence in Germany has slumped to a 4 year low.

The Ifo survey of future expectations fell to 98.8 in February, down from 102.3 in January.

"It is the first time this index is below 100 since October 2014, signalling clear and acute downside risks to the economy," says Claus Vistesen at Pantheon Macroeconomics, "the dip below 100 in the expectations index is particularly alarming, as this usually has been a very accurate recession signal. If it remains depressed in March, it would be a bad omen."

PMI's Weigh 

This week's under-par Manufacturing and Services PMI data from financial information provider Markit, has further increased the probability that the ECB will react with an aggressive monetary easing strategy at its March meeting, which in terms of scope and duration may be larger than previously expected, and which is therefore likely to push the euro even lower.

The preliminary estimate for Euro-zone Composite PMI, which is made up of a mixture of both the Manufacturing and Services Components, came out at 52.7 in January, undershooting expectations of 53.3, and hitting a 13-month low.

The Services component fell to 53.0 from 53.6 in January – also a 13-month low, and Manufacturing PMI fell to 51.0 from 52.3 – a 12-month low.

The Markit report which accompanied the data release said:

“Business activity in the eurozone grew at the slowest rate for over a year in February and deflationary pressures intensified, according to flash PMI® data.”

The report pointed to a fall in new business, with figures, “..reflected a waning in growth of new orders for a third successive month, resulting in the smallest rise in new business for 12 months.”

The lack of new business had impacted on rates of employment:

“With outstanding business stagnant, firms limited their hiring of new staff, leading to the weakest net increase in employment for five months.”

Manufacturing, in particular, was singled out:

“Manufacturing output showed the smallest increase since December 2014.”
Whilst Services fared somewhat better:

“Services fared better, though nevertheless saw growth weaken to the slowest since January of last year. Moreover, a sharp deterioration in optimism about future activity growth in the services sector points to further weakness in coming months.”

France was particularly hit by a contraction in overall business activity whilst Germany held up marginally better, due to strong Services counter-acting a steep fall in manufacturing.

All other Eurozone countries saw activity fall to its “weakest rate since February 2015.”

Deflationary Fears

Of particular note in the report accompanying the PMI data, was the slow-down in prices for both Manufacturing and Services, which indicate deflationary forces at play:

“Deflationary pressures meanwhile intensified.

“Average prices charged by companies for their goods and services fell at the steepest rate for a year as firms competed to boost sales.”

The report goes on to further explain that Manufacturing prices fell steeply, due to drop in ‘input costs’ reflecting the fall in the price of raw materials due to weakness in commodities:

“Manufacturing prices fell especially sharply, with purchase costs dropping to the greatest extent since July 2009 on the back of low global commodity prices and intense competition among suppliers. Suppliers’ delivery times, a key gauge of capacity utilisation, pointed to the weakest supply chain pressures since July 2013. Factory gateprices showed the largest monthly fall since June 2013.

Services costs, however, which are not affected by the fall in commodity prices, also showed deflation, due more to low demand and stiff competition, proving that pass-through from global factors was not the only reason for subdued inflation:

“Input costs in the service sector continued to rise but prices charged fell at a slightly sharper (though relatively modest) rate, reflecting stiff competition and weak demand. The divergence points to squeezed margins.”

Markit’s Chief Economist, Chris Williamson, commenting on the piece, said:

“Disappointing PMI survey data for February greatly increase the odds of more aggressive stimulus from the ECB in March.”
Inflation was of particular concern:

“..deflationary forces intensified. Economic growth is likely to slow below 0.3% in the first quarter unless we see a sudden uplift in March, which on the basis of the forward-looking components of the PMI seems unlikely.”

Summing up Williamson said:

“The need to compete on price has become increasingly widespread amid weak demand, leading to an escalation of deflationary pressures that will worry policymakers.”
In a note reflecting on the PMI release, analysts at Lloyds said:

“Deflation risks have also started to emerge again, with headline inflation likely to fall back towards, or even below, zero in the near term, while longer-term inflation expectations have declined since the start of the year.”

Adding more QE was also likely from the ECB:

“Financial markets are currently pricing in about a 10bps reduction in the deposit rate to -0.4% in March, with a further 10bps cut later in the year. A further increase in the size of the QE programme is also likely, possibly an increase in the monthly pace of purchases or an extension of the time limit beyond March 2017, although this could run into resistance from the more hawkish members of the Governing Council.”

BofA had been expecting the ECB to respond more aggressively after perceiving an undercurrent of hawkishness in the ECB minutes, and this combined with this morning’s poor PMI data is pointing to a disproportionate response from the European Central Bank:

“There was even more to the ECB minutes, in our view, on communication, overshooting and in between the lines on policy tools.

“This fits with our call for March, a strong package with a focus on QE, TLTROs and communication, rather than the depo cut.”
Targets

200-Day and Below

Technical analysts expect that the pair will fall to the next target at the 200-day MA, situated at 1.1027, however, given the negative fundamental backdrop, there is also still further downside potential from there.

A clear break below support from the 50-day MA and the R1 monthly pivot at 1.0975 would probably confirm more downside.

With a break below 1.0945, probably leading to a continuation down the next target at 1.0890.