US Dollar Outlook: 6 Cent Break Higher Against the Euro Possible

The charts are showing the Euro to Dollar exchange rate vulnerable to another sell-off in the coming week - here are the levels and events to watch for those with an eye on this market.

The EUR/USD pair broke down out of a long-term rising channel following the Brexit referendum result over fears about the integrity of the European Union.

It has since recovered back above 1.10 to the lower channel line roughly at the level of its break.

From here, a retest of last Friday’s 1.1165/70 high would not be surprising but the key 1.1210 resistance is expected to hold for a deeper pull-back to 1.1095/00.

This recovery may be what technicians call a ‘throwback’ or ‘return move’ – a pull-back into the level the exchange rate has just broken below or above.

This is normally followed by a last ‘air kiss’ goodbye before the rate resumes falling or rising in the direction dictated by the breakout.

In the case of EUR/USD this would indicate the probability of a bearish resumption starting next week, and the exchange rate moving lower again.

The next major target to the downside is the S1 monthly pivot at 1.0868, a level which prices tend to respect and traders use to trade counter-trend, therefore stalling directional moves.

A break below the 1.10 level might provide compelling confirmation of a resumption lower.

The height of the channel gives a fairly reliable target for the break, and this channel is 6 cents high, indicating a potential 6 cent break lower, which from the original breach at 1.12 gives an eventual target at 1.06 – attractively near the range’s mega-long-term lows.   

As such, it is possible the pair could fall all the way to the 1.06s in time.

It May be a Four Day Week for the US, But There is Important Data to Watch

If global risk appetite continues to remain under pressure, then there is a good chance that the dollar will gain a lift, given its new role as safe-haven has eclipsed interest rate rise expectations as the currency’s main driver temporarily.

However, assuming risk conditions settle down, there is a strong possibility that analysts will begin to speculate once again as to the likely possible date for a rate rise at the US Federal Reserve.

Of course this pro-USD outcome is highly depenent on the tenor of the economic data due for release over coming weeks.

This is a short week for the US as the biggest economy in the world celebrates one of its most important holidays, the 4th of July Independence Day.

Despite this being a four day week for the US, there will be significant
US data which could move financial markets.

The key US data everyone will be watching will be Friday’s Employment Situation report of which much of the attention will be on the non-farm payrolls data (Bloomberg median forecast at 180k from 38k in May).

Recall that the last two reports have come in well below analyst forecasts, suggesting the US economy may be slowing down.

Currency traders will keenly await this month's release to see whether the slowdown is part of a trend or rather a blip.

Ahead of the US Labor report, we will have the June ADP employment change data on Thursday (7 Jul) instead of its usual Wednesday release due to today’s US  holiday  (4  Jul). 

In this sense NFP’s will provide an important insight, since for the last two months they came out well below expectations, and if this is followed by a third lousy month, more serious concern may be warranted, which would delay rate rises well into the future, and possibly set alarm bells ringing about a potential recession on the horizon.

A Simmering Banking Problem in Italy Could Weigh on the Euro

One major hazard on the radar for the euro is a simmering banking crisis in Italy.

The volatility in the aftermath of Brexit has exacerbated the already fragile financial state of Italian banks.

The main problem appears to be the 200bn in non-performing loans they are carrying. This combined with the hit their shares took following Brexit have pushed several over the edge.   

Given the EU will not allow Renzi to use state funds for a bailout, it is likely -  according to an opinion piece in Friday’s Financial Times -  that creditors and bond holders will have to take a hit – otherwise known as a ‘bail-in’.

Clearly the potential danger is that the Italian banking crisis may spread contagion, specifically that other creditors will have to write off debt, in other countries, and although the financial system is stronger than previously, there remains a risk, not seemingly priced into the euro that this could happen.

One positive effect for the euro, resulting from the banking crisis may be a trend for Eurozone banks to repatriate funds from abroad, both to buffer their balance sheets and because globally returns have fallen.

This has led to a short-term euro-positive call from Morgan Stanley’s Strategist Hans Redeker.  

He further argues that with German Bunds already yielding less than zero there is little room left for them to go even lower, as progress into negative territory is disproportionately slower. This also limits downside for the currency.

Falling yields -  or returns - globally, have also reduced the incentive for investors to send money abroad, further limiting downside for the single currency:

“With the 10y German Bund now yielding below zero, it is more difficult for bond yields to fall in response to any growth shock to the economy. As a result, currencies are unable to weaken in response to growth weakness. Similarly, investment returns globally have fallen further, meaning that the propensity for a eurozone investor to send money abroad has reduced. These two factors are making us less bearish on the EUR in the shorter term.” Said Redeker.