EUR/USD Rate (EUR/USD) Forecast to 'Relocate Significantly'

The euro to dollar exchange rate (EUR/USD) shot higher as words from the US Fed mix with positive developments from a technical perspective leading some to predict a move out of long-standing ranges.

• Dollar lower as US Fed Chair Janet Yellen dismisses agressive action on interest rates
• Improved German inflation numbers provide impetus
• Conversion expected to 'relocate significantly' again over coming weeks

Thanks to better than expected economic data and a weaker dollar, the euro came within a few pips of its 2016 high.

Eurozone business and industrial confidence improved in the month of March but most importantly inflation rose 0.8% this month in Germany, which was double the previous month and higher than expected 0.6%.

Prices are beginning to rise, a sign that the ECB's efforts could finally be paying off which suggests the need for further EUR-negative interest rate cuts and quantitative easing may be waning.

However, for the EUR/USD exchange rate it is the US dollar that is in the driving seat.

The dollar continues to suffer the impact of US Fed Chair Janet Yellen's warning that Federal Reserve interest rate rises are likely to be a lot slower than markets had previously anticipated. 

Yellen told an audience in New York that "caution is especially warranted" in raising interest rates at the present time as the impact on the economy of raising rates from such a low base are asymmetric.

The Fed chair says she needs notably stronger data releases than currently expected to convince her further rate rises are nedeed.

This has lead markets to speculate that the Fed may not raise interest rates on two occasions in 2016 as currency traders previously assumed.

It also means that Friday's non-farm payrolls release will attract more attention than usual.

The promise of higher interest rates has been the bedrock of US dollar strength over recent years, and anytime the US Fed rows back from raising rates you can bet the dollar will fall.

In short, the US Fed is uncertain on how its policy will evolve, and currencies hate uncertainty. What makes Yellen's comments all the more cruel is that they fly in the face of the hints given by other Fed decision-makers.

Over recent days a number of Fed speakers had hinted at being more agressive in raising rates; the dollar rose alongside. What goes up must come now come down.

Can the Break Above 1.13 be Sustained?

The move higher in the EUR to USD to levels back above 1.13 are significant. 

The conversion rate was rejected at 1.13 earlier in the month. The question is - will the euro fail at this level again? There seems little appetite for the euro at this rarefied altitude!

Nevertheless, the shared currency has to be preferred going forward in our view.

The directional bias notable in 2014 and early 2015 was all-out negative, which would prima facie imply an upcoming negative resolution. 

However, as noted by Lucy Lillicrap at Associated Foreign Exchange, "enough base work is apparent that an upside break-out would have to be respected."

The euro is trading above the 20, 50 and 100 day moving averages and this confirms that, technically, momentum remains biased to the upside.

“I remain positive on the euro whilst the support band $1.1050/$1.1100 remains intact and the euro has built from a base of support at $1.1142 posted last Thursday,” says Richard Perry at Hantec Markets.

LMAX Exchange meanwhile forecast the recovery in the EUR to USD rate to be tested just beyond 1.13:

“The recent push back above 1.1200 still leaves open the possibility of gains to extend towards the next key resistance zone in the form of the 2016 high from February and October 2015 peak at 1.1377 and 1.1495 respectively.”

We have reported over recent days that some are even targetting an extension higher to 1.17 confirming there is no shortage of positive commentary coming out of the analyst community.

Analyst Robin Wilkins at Lloyds Bank says 1.17 is only possible should 1.13 be broken. Interestingly, 1.20 remains a prospect if such a break occurs:

"Medium/long-term we remain trapped in a range since last March between 1.0450 and 1.1465. We expect this range to remain intact for now, with only a move through 1.1375/1.1465 risking not only a re-test of last August’s spike high to 1.17, but potentially a move towards 1.20-1.23 before the market finds renewed and significant supply."

Lloyds are however inclined to stick with the view that the recent range between 1.1350 to the top and 1.1110 at the bottom will continue to persist.

Trainfular re-Consolidation Implies a Break-Out

The past 12 months triangular re-consolidation pattern for many USD/European pairings looks to be approaching maturity with prices expected to relocate significantly again over coming weeks argues AFEX's Lillicrap who we heard from breiefly earlier in this piece.

Lillicrap notes that a not too dissimilar situation pertained following the previous major sell-off for this pair between 1998 and 2000: Values then triangulated until mid-2002 then subsequently broke back upward.

Looking still further back another such narrowing sequence between 1997 and 1998 also resolved in a contra-trend manner and although this was eventually reversed it was not until the market had retraced almost half of its prior sell-off.

"Putting that into context now would infer EUR/USD tracking back toward 1.2000 even if such a rally proved ultimately corrective," says Lillicrap.

Fundamentally Speaking: Parity is Still Possible

Analysts at DNB Markets have confirmed to clients that the euro to dollar exchange rate pairing is on borrowed time at current levels.

In a note to clients DNB have confirmed their forecast for EUR/USD over the 1, 3 and 12 months are 1.10, 1.07 and 1.00, respectively.

Why so negative then?

DNB are sticking with the theme that the difference in interest rates between the Eurozone and US Federal Reserve will be the ultimate driver of direction in EUR/USD going forward.

Interest rates matter - if rates in the US rise again in 2016 the advantage over the negative rates in the Eurozone only grows.

This should accelerate the flow of capital from Europe to the United States, driving up the dollar in the process.

“Diverging monetary policy will continue to favour the USD. We see a next Fed hike in June and another 2 hikes before year end. More aggressive hikes in 2017,” say DNB, Norway’s largest bank.

The ECB is on the other hand expected to cut the deposit rate by another 10 bps and increase asset purchases in March.

That said, over the longer-term the euro should recovery.

“Despite the anaemic recovery in the Eurozone, the risk of an unfavourable outcome will gradually be reduced,” say DNB, “Eurozone current account surpluses and central bank demand for EUR should result in a stronger EUR going forward.”

What to Watch Going Forward

- US non-farm payrolls data (Friday) is expected at +197k. The unemployment rate is expected to hold steady at 4.9%.ISM Manufacturing (Friday) is expected to pick up to 50.7.

- Yellen to speak before Economic Club of New York (tonight). Fed’s Dudley speaks on Thursday

- Eurozone Flash Inflation (Thursday) is expected at -0.1% y/y,