Euro to US Dollar Rate in Reverse but to Remain Supported as ECB Refrains from Monetary Easing at September Meeting

Credit Agricole have told clients they see a diminishing chance of further interest rate cuts and an expansion of the quantitative easing coming out of the ECB in September, this is a positive for the Euro.

The Dollar profited nicely from hawkish comments by Fed’s Yellen and Fischer at the Jackson Hole conference.

Interest rate differentials between the US and Eurozone widened substantially, as investors now discount a greater chance of a September/December hike. The widening of rates in favour of the US saw demand for the USD grow as foreign investors sought out the improved yield.

The EUR to USD exchange rate has come under pressure as a result and commences the new week from 1.1195.

The pair opened the previous week at 1.1307, confirming short-term momentum has turned and now favours the Dollar.

The Eurozone's economy continues to expand with no notable economic impact stemming from the UK's vote to exit the European Union. 

The question for the Euro in September will be whether or not this translates into change at the European Central Bank (ECB) when they deliver their next policy decision on the 8th of September.

ECB President Draghi’s prognosis of a 0.3-0.5% break on growth now seems rather excessive in light of recent data and has convinced analysts at Credit Agricole to expect no change to be delivered by the ECB:

“The EUR has been well supported of late. This appears to be on the back of stable ECB rate expectations and reduced sensitivity to risk sentiment.

"Regardless of inflation expectations as measured by 5Y inflation swaps being close to historic lows, we see limited scope for the ECB to consider a more dovish monetary policy stance any time soon. This is especially true when it comes to interest rates.”

If analysts are correct we would expect downside risks to the EUR/USD exchange rate to remain limited.

EU Inflation Data, US Employment Data to Dominate the Agenda

The Euro’s key data release in the week ahead will be flash Inflation in August.

Nordea Bank’s Bo Jakobsen expects an uptick:

“The main data point is the flash inflation reading for August on Wednesday. We expect an unchanged core rate and a small uptick in headline inflation (to 0.3% y/y), driven by energy prices. The risks to our call are balanced. Unemployment should continue on its downward trend (Wed). These data are among the last to be published ahead of the next ECB meeting on 8 September.”

A steady inflation reading combined with a changing global risk outlook, which may be about to take a hit from falling commodity prices, and the Eurozone’s continued current account surplus, means downside may be limited for the euro.

The Dollar, however, may experience more upside if data in the week ahead supports a firming up of rate hike expectations.

This will be especially true if Non-Farm Payrolls beat expectations, however, given the data is for August, and the holiday season, this is by no means an expectation, and most analysts if anything, seem to be forecasting a slight slowdown after June and July’s figures knocked it out of the park.  

EUR/USD Technical Forecast: On Balance Greater Risk of Downside

The rather chaotic daily chart does not lend itself to a technical analysis, however one technical feature which does stand out and could provide a signpost for future things to come, is the large bearish candle (see chart below) which followed Janet Yellen’s testimony on Friday, and bodes negative for the rate.

The two moving averages (MA) situated in the lower 1.11s, however, may keep the decline from being deep: the 50-day MA is at 1.1141 and the 200-day at 1.1120.

Nevertheless, a move down to those MA’s does seem highly likely.

Alternatively, a break above the 1.1367 highs would probably confirm a continuation higher to a target at 1.1430 and the post-Brexit highs.

Scotiabank’s Chief FX Strategist, Shaun Osborne, is also bearish for the pair stating in his most recent note that, “EUR’s retreat from its August 18 high has seen a sequence of lower highs and lows, generating a descending channel whose bounds suggest support at 1.1220 and resistance at 1.13. EUR’s recent break of its 9 day MA (1.1301) has shifted the focus to further downside with risk to the 21 day MA (1.1214).”

He also sees 2yr sovereign bond spreads as “a drag on the Euro,” as they have reached an overstretched downside limit of -140 basis points (before Yellen’s speech).  

Overall, given the theme of enduring Euro strength, but Dollar strength being more dependent on firming rate expectations, traders may wish to prioritise US data to effectively trade this pair.

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