EUR/USD Exchange Rate Enters New Period of Decline

The Euro is under notable pressure as market participants bet on an acceleration of the US Federal Reserve's rate tightening path as Donald Trump’s infrastructure spending plan is expected to boost inflation and growth.

The EUR/USD opened the week at 1.0830 and is presently quoted at 1.0748 which brings us nearer to the bottom of the range that has been in place since early 2015.

The lowest level reached since 2015 is 1.0462, hit in March 2015 however markets will be eyeing the 1.0525 lows reached on November 2015.

The underperformance is understandable when viewed through the list of issues driving the Dollar's outperformance against the Euro.

“We note the stark policy divergence between the US and EU at both a monetary and fiscal level; the Fed is tightening and ECB is loosening. Fiscal policy can ramp up in the US; it can’t across the EU. The US election result is known; EU nations are not. Eyes will be on how the National Front polls in France. Sometimes it’s a case of better the devil you know that the devil you don’t. This accentuates a positive USD bias,” says Philip Borkin, Senior Economist at ANZ.

EUR/USD slid 4.65% after hitting 1.13 in the immediate aftermath of the US election results.

"The entire US yield curve has shifted to the upside with the monetary sensitive 2-year sovereign yields reaching 0.98%, the highest level since March this year," says Yann Quelenn, market analyst at Swissquote Research.

The long-end of the curve accelerated faster than the short-end with 10-year yields climbing to 2.23%, while 30-year yields rose to 3.02% from 2.55%, bolstered by firmer inflation expectations.

Market expectations for a December interest rate rise at the US Fed hover around a sure-fire 80% which is supplying bucket-loads of confidence to USD buyers at present.

The technical outlook for the EUR/USD pair remains negatively aligned and we would anticipate further declines.

EUR/USD formed a long exhaustion bar on the day of the presidential election, signalling the uptrend may have become 'exhausted' and there is an increase in the probabilities of more downside.

The exhaustion bar is also a Japanese candlestick shooting star, enhancing its bearish forecasting value.

The MACD indicator is crossing below its signal line providing a bearish signal.

The exchange rate has reached support at the current 1.0830 lows, and there is a possibility it could rotate and move higher, however, in the absence of any bullish price action a downside break is possible.

A clear break below tough support just below the current lows, and below 1.0790 would probably lead to a move down to 1.0700.

"We anticipated 1.0820/1.0845 to act as a major support and expected this level to at least temporary check the recent decline in EUR," says a note from strategists at United Overseas Bank (UOB) in Singapore.

However, "the ease of which these levels are taken out coupled with daily MACD crossing back into negative territory suggest that the outlook for EUR has shifted to bearish".

The immediate target for UOB is at 1.0710, below this level, the next significant support is closer to 1.0640 followed by the 2015 low of 1.0535/40.

"In order to maintain the current momentum, any rebound should not move back above 1.0920," say analysts in a strategy note to clients.

Dollar on the Up

The Dollar is on the up after Trump’s win promises more money to flow into the economy from his fiscal stimulus programmes.

This should raise inflation and lead to higher interest rates, which will, in turn, strengthen the dollar as they will attract more foreign capital flows.

Much of the focus this week will be on inflation data out on Thursday and also Janet Yellen’s testimony to Congress on the same day.

Both these events will shape the outlook for the dollar.

Whilst a December rate hike is all but priced in with odds now at 83%, the risk, is if anything of Yellen being cautious, and if so it would weaken the dollar.

String inflation, however, and a more confident Yellen are likely to push the currency higher as traders start to price in a steeper rate hike trajectory in the medium term.

Euro Woes

The Euro is vulnerable to more weakness as politicians fear the rise of the thing that the original founders of the EU –set up the EU to prevent – ergo a rise in nationalism which could pave the way for conflict and possible war.

Whilst we are nowhere near another war in Europe it does seem like the very foundations of the European project are under attack, and as one of its leading intuitions so is the single currency.

The immediate threat comes from a referendum in Italy, which instead fast becoming a vote of no-confidence in Mateo Renzi’s centre-left administration.

The next threat after that sources from Austria where the right-wing, populist, nationalist candidate is gaining ground in the wake of Brexit and Trump.

"EUR/USD had not seen a positive day this past week and now investors are worried that nationalism will escalate in Europe. Italy has a referendum on Senate reform on December 4.

"If voters vote 'yes', it would allow for continued progress on an ambitious reform package; but if they vote 'no', it could lead to political and social turmoil. Prime Minister Renzi said he would resign if the reforms were not passed.

"Austria also has a Presidential election 3 weeks from now and the fear that the populist far-right candidate could win in the closely fought race is growing," said Director of BK Asset Managment, Kathy Lien.

Later in 2017 there are a host of other elections in key Eurozone strongholds which have the potential to upset the whole fabric of the union.

Although there are other factors supporting the Euro – the repatriation of Euro-denominated funding finance from the emerging markets as investors bail, the better outlook for Eurozone banks because of rising yields, and a lower likelihood of ECB easing, it seems politics is king now, in the list of drivers of the currency.

Fears of European Populist Surge Overdone

Not everyone is convinced by the argument that the US is facing a populist surge which would in turn threaten the Euro.

"Much of the media love a contagion story. Here is what has driven me completely mad: Even otherwise well informed media have drawn parallels between Trump (after Brexit) and the upcoming Italian referendum. As you hopefully know, the Italian referendum is about simplifying governance and has absolutely nothing to do with populism," argues Eric Nielsen at UniCredit.

Nielsen hopes Renzi wins the referendum because it’ll then become easier to get reforms through, but if he doesn’t, Nielsen argues it’ll be “more of the same”, rather than a sign of any “populist wave”.

"Certainly, the several respected Italians who, for various reasons, say they’ll vote “no”, would surely object to being thought of as part of a populist wave," says Nielsen.

The UniCredit analyst also points to the electoral system in Europe as being one that protects against unexpected shifts in power.

"While there is good evidence that some European countries include a bigger share of extreme-leaning voters than, say, maybe the 14% in the US (I’m generously guessing that half the Trump votes were extreme protest votes), any fraction of extremists below 30%-40% won’t come to significant power in Europe because of our different electoral systems," says Nielsen.

Data this Week for the Euro

Friday sees the second estimate of October CPI.

The preliminary result came out at 0.5% and expectations are for this to be mirrored by the second estimate.

Clearly, this may have important implications for European Central Bank (ECB) monetary policy going forward.

A fall would indicate further deflation and increase the chances of further stimulus from the ECB.

Monday sees speeches from ECB’s Draghi and Praet at 13.45 and 18.45 (GMT) respectively.

Tuesday also sees the German and Eurozone ZEW sentiment index out at 10.00, which is considered a good indicator of future growth.

The ZEW is composed of interviews with financial professionals and is considered a good leading index.

The ZEW is likely to follow a generally improving trend in sentiment data in the Eurozone, according to Commerzbank’s Rolph Solvene:

“The recent improvement in business sentiment –the Ifo business climate and the purchasing managers’ index have increased noticeably of late – inspires hope that this will not change in the coming months.

“As a consequence, sentiment among analysts has improved; the Sentix index already reflected this (chart 7), and the ZEW index will likely follow in the week ahead, rising nearly 10 points to 15 points.”

German 3rd quarter GDP at 07.00 is expected to come out at a sluggish 0.3% from 0.4% previously.

Commerzbank’s Solvene, meanwhile, thinks it will probably undershoot and come out at 0.2%.

Data for the Dollar

From a data perspective, the highlight of the week for the dollar is likely to Federal Reserve Chairwomen Janet Yellen's testimony to Congress on the economic outlook on Thursday, November 17 at 15.00 (GMT).

Her words will be scrutinized closely for hints as to whether she will raise interest rates in December as is currently expected by the overwhelming majority of analysts.

Core CPI in October, is another key release out on Thursday at 13.00.

As can be seen from the chart below CPI has been steadily rising, and a further 0.2% rise in October, will continue the trend.

Rising core inflation, which means inflation without volatile food and fuel elements, is likely to spur a rise in the Dollar.

Producer Prices, released at 13.30 (GMT) on Wednesday 16, are expected to show a 0.3% rise mom in October and are also an important signifier of future inflation expectations.

Although the Fed is now almost certain to raise interest rates at its December meeting an unexpected rise or fall in the data could impact on those expectations.

Rapidly rising inflation could lead to the formulation of a steeper interest rate trajectory by the Federal Reserve, in which it increased rates more rapidly than is currently assumed.

Higher interest rates are likely to support the dollar as they attract more capital flows from international investors attracted by the higher returns.