EUR/USD Exchange Rate Risks Further Falls as USD Sell-Off Labelled 'Overdone'

The euro to dollar exchange rate has hit tough resistance at 1.1300 which will continue to prove a difficult barrier for euro buyers to overcome.

• EUR/USD at 1.1248 having been rejected by 1.13 barrier, as expected
• Dolllar seen as oversold
• HSBC reckon EUR/USD at 1.20 by end of 2016

While the euro could well continue to benefit from a wounded US dollar, and signs that the ECB could abandon targeting a weaker exchange rate altogether, the EUR to USD rate will likely struggled to advance above 1.13 based on the underlying dynamics of the FX market.

Underlying market structuring has shown time and again that the sheer wall of selling interest above 1.13 is likely to persist, and for that reason we would expect gains to be hampered.

The euro to dollar conversion traded above 1.13 briefly last week when, as expected, a triggering of sell orders snuffed out the advance.

Technical demand to sell then combined with oversold conditions in the US dollar complex following the break-neck pace of the recent selloff.

"The decline in the greenback has driven many major currencies into overbought territory and a correction at these extreme levels also seems likely. This suggests that currencies could move into a more consolidative mode with rallies in the dollar being sold as we only have second tier U.S. data on the calendar," says Kathy Lien at BK Asset Management.

The dollar has struggled of late as markets get the sense that the US Federal Reserve is reluctant to raise interest rates more than twice in 2016 suggesting currency inflows into the United States will not be as strong as initially anticipated by traders.

Dollar Sell-Off Overdone

Nevertheless, the declines in the dollar, and downgraded interest rate forecasts, fly in the face of consistently strong data.

“Despite the somewhat dovish Yellen rhetoric the US economic surprise index has been on something of a tear since early February; we are now near November’s cyclical highs,” says Jeremy Stretch at CIBC in London.

“This suggests to our minds that the post Fed USD move, including in front end spreads  is overdone. Hence we maintain a bias towards a USD rebound into Q2,” says Stretch.

Stretch is focused on the US dollar index (DXY), whose single largest component is the euro, and he believes there to be value in the DXY down around the 94.70 area.

“We continue to view the USD sell-off as overdone. Hence this favours a medium run rally back towards early month highs at around 98.50,” says the analyst.

Nevertheless, the CIBC analyst concedes he would be unsurprised should the DXY head back towards 96 into the close of the week.

ECB Could Surprise Again, Push Euro Lower

Markets have also spurred the euro higher on indications the ECB is abandoning plans to chase the euro lower to boost Eurozone inflation and economic growth.

At the press conference following the March 10 policy decision markets latched onto the suggestion that chasing ever-lower rates was ultimately futile.

We have since however had the ECB Chief Economist, Peter Praet remind the market that the ECB have yet to reach ‘the physical lower bound’ in terms of rates.

“With medium run inflation expectations once again heading lower in recent sessions such a statement is designed to remind investors that the ECB are not prepared to tolerate an aggressive EUR appreciation,” says Stretch.

Note that CIBC believe a weekly close below 1.1195/1.1206 would underline that February highs at 1.1376 should remain out of reach until well into H2.

Forecasting EUR/USD to Move Higher to 1.20

While short-term dynamics argue in favour of the USD, longer-term the EUR/USD will move higher argue HSBC.

HSBC join UniCredit Bank in arguing the European Central Bank and Bank of Japan are now likely to disengage from an overt policy of weakening their exchange rates.

"We have been counter consensus in our view of EUR-USD strength, arguing that we were likely to see a convergence in policy expectations rather than a divergence. This is how it is playing out," say HSBC.

HSBC are forecasting EUR/USD at 1.20 by the end of 2016.