Euro / Dollar Rate Recovery Fading, Resistance Levels Seen as too Strong

The EUR/USD exchange rate traded higher mid-week on the back of a powerful stock market recovery, but the move is seen fading on Thursday the 30th.

A month-end surge in global stock markets has allowed risk-on assets such as the euro and British pound to recover in sympathy.

However, at the time of writing we are seeing the euro slip back as the US dollar is bid higher again, opening up the prospect that the bounce was merely driven by month-end and quarter-end rebalancing by portfolio managers. 

Indeed, for the euro, "the momentum indicators are still in deterioration mode and there is still a sense that rallies will be seen as a chance to sell," says Richard Perry at Hantec Markets.

Perry believes bulls will want to see a push through $1.1188 to suggest there is any real substance behind a recovery.

"My expectation is that this is a settling period before further selling pressure to retest $1.0968 and then the low at $1.0909," says Perry.

There is a correlation in performance witnessed between the EUR/USD and GBP/USD with the euro also suffering on negative sentiment towards questions over the future of the UK-EU political and economic structure.

There remains the risk that unless concrete steps regarding the future are made soon GBPUSD weakness could see EURUSD take aim at 2003 lows hit in March 2015 below 1.05.

Asmara Jamaleh at Intesa Sanpaolo points out that current levels in the EUR/USD pair are not particularly cheap as the exchange rate was at 1.09 only three months ago.

Given the extraordinary nature of the Brexit event, which has no historical precedents, Jamaleh says there are no sufficient elements to rule out the risk of new lows being hit below the ones hit on Friday. 

Intesa Sanpaolo are forecasting downside between EUR/USD 1.08 and 1.05.

Technically, the charts tell us EURUSD has turned bearish and negative momentum increased.

EURUSD is pressured while below 1.1066 and will likely carve out further losses.

Analyst Karen Jones at Commerzbank is in agreement with the idea that strong resistance will cap the euro's advance.

"The market is expected to find that the previous 2015-2016 channel currently at 1.1168, should act as resistance. While capped here, we continue to view this as a strong negative signal," says Jones.

It leaves the market on the road to 1.0821 suggests Jones; the March low, and then the base of the second channel at 1.0564.

Note the 1.0457 March 2015 low is also found in this vicinity together with the 1.0600 30 year support line.

Soc Gen: Bet Against EUR/USD

How low could the decline extend?

According to Societe Generale, the French investment bank, the European consequences of the UK vote will come slowly, therefore once the fireworks are out we could witness a gradual grind lower in the euro dollar exchange rate.

Growth in continental Europe will be weaker as a result of the EU’s biggest trading partner experiencing slower growth, but if Eurozone GDP growth were to average, say, 1.3% instead of 1.6%, that would not be disastrous suggest analysts.

It would merely highlight the need for the European Central Bank (ECB) to maintain easy policies, even in the face of German resistance.

If the ECB were to introduce a more accommodative set of policy measures we could well see the euro trade with a softer tone over coming months.

However, cutting rates yet further while increasing the purchase of bonds is not without problems.

“That’s asking more of a central bank with dwindling ammunition, and while the euro won’t fall fast, the risks are tilted to the downside from here,” say Societe Generale.

The 1.04-1.16 range for EUR/USD will likely hold, but Soc Gen forecast the pair will spend more time in the lower half of that range going forward.

Forecasting the euro to remain in its recent range against the US dollar makes sense as we note that Fed fund futures are now completely discounting another interest rate rise at the US Fed in 2016.

In fact, there is even a chance of a rate cut.

Therefore, the divergence in interest rates in favour of the US dollar could well be capped, ensuring the EUR/USD does not fall all the way to parity.

The ECB would also probably have to live with a growing concentrating of southern European bonds in the hands either of southern European banks or the ECB.

Thus, calls for EUR/USD to hit parity still look a little extreme in our view."

ING: EUR/USD to Remain Supported

ING have just released their foreign exchange updates following the EU referendum results and have confirmed downgrades to the EUR/USD.

However, the downgrades suggest the euro will ultimately remain above 1.08.

Some of the reasons for EUR/USD resillience are:

• Dovish re-pricing of the Fed cycle
• The ECB’s 2012 introduction of the OMT programme
• The ECB’s 2015 introduction of the PSPP programme
• EUR/USD valuation (cheap at 1.10 vs slightly over-valued during 2010-12 crisis)
• Eurozone current account surplus now worth 3% of GDP (1% in 2012)

If anything, the risks are to the upside.

“One other issue worth mentioning is our opinion that the ECB has to tread very carefully with the EUR. One mis-step, potentially one where a new deposit rate cut hurts, rather than helps the Eurozone banking sector, could see a parallel drawn to the BoJ’s actions in January – actions which resulted in a stronger, not weaker currency,” says ING's Chris Turner.

Volatility Expected to Die Down

The EU Referendum delivered a shock to the financial markets, and we saw on Friday one of the most volatile days ever seen.

Volatility will likely continue this week, particularly in currencies, stock indices and interest rate futures, but will not likely continue at such elevated levels as were seen on Friday.

According to Phil Seaton at LS Trader, when volatility reaches extremes, it rarely lasts for an extended period.

“Many markets moved on huge volume. When such high volumes are seen it is usually either at the start of the next move or indicates exhaustion at the end of a move. Price action this week may give us an indication as to whether Friday’s moves were overdone hysteria or the start of much deeper trend moves,” says Seaton.

So from here, it could well be a case of a steadier, less flashy decline