Bet on a Fall in the EUR/USD Rate say Societe Generale as It is Vulnerable to Negative Surprises

There's life in the old Dollar yet, which could even hit EUR/USD this week, particularly if the ECB chides markets over excessive expectations on Thursday.

The Euro-to-Dollar rate could fall over the coming days, according to strategists at Societe Generale, as its recent rally has left it vulnerable to negative surprises at a time when the Dollar could be due a break in the sun.

Europe’s common currency has gained around 2% in January as traders warmed to the idea that the European Central Bank might soon begin to provide more clarity on the likely timing of its first interest rate rise since the financial crisis.

"If CFTC data and option risk reversals are to be believed, there seems to be unbridled optimism surrounding EUR/USD, which makes it vulnerable to negative surprises," says Alvin Tan, a strategist at Societe Generale.

“SG Economics is not only expecting the ECB to hold its policy setting and rhetoric steady this week, but that President Draghi will push back against mounting speculation that ECB rate hikes could occur in early 2019.”

Meanwhile, the Dollar index has dropped by an equal measure as the US currency buckled under the weight of concerns about political dysfunction in Washington.

Investors have also increasingly been drawn to alternative markets that have more upside to offer in return for their cash, another source of pressure on the Dollar, which partly explains why the greenback has failed to draw a boost from expectations of a faster pace of rate hikes from the Federal Reserve during 2018.

“The dollar has not caught a lift from rising US bond yields because the market pricing of the terminal Fed Funds rate remains trapped within the range of the past five years, but the latter is now testing the ceiling of the range,” says Alvin Tan, a strategist at Societe Generale.

“A break higher on that front could finally see higher US yields bolstering the dollar.”

The current week could offer opportunity for speculators if it yields a break with the recent market trends that have driven both Dollar and Euro to their respective extremes this January.

Above: EUR/USD shown at weekly intervals.

“Our technical analysts noted that EUR/USD formed a shooting star pattern last week after it paused ahead of the median of the daily upward channel near 1.2340/80, though symptoms of a retracement are still lacking,” says Tan.

“Previous highs at 1.21/1.2070 will provide near term support, while 1.2290 will present immediate resistance.”

Tan and the Societe Generale team are advocating to clients that they consider betting on a fall in the Euro-to-Dollar rate. Selling it short from 1.2255 and aiming for a fall to the 1.2100 level, while keeping a stop loss at 1.2330.

“We would recommend going short EUR/USD tactically to trade a dollar bounce triggered by rising Fed Funds expectations,” Tan remarks.

A potential catalyst for the turnaround might come Thursday when the European Central Bank holds its latest monetary policy press conference. Pre-meeting signals from policymakers have been conflicting.

On the one hand, Jens Weidmann said last week that it could soon be appropriate for the ECB to warn markets of an eventual rise in interest rates. This is a very bullish development for a currency.

But, on the other hand, ECB governing council member and head of France's central bank Francois Villeroy also told reporters last week that the Euro’s gains in recent months could inhibit the ECB’s ability to exit its QE program.

The ECB must exit the quantitative easing program before it can begin to think about raising interest rates.

Tan and the Societe Generale FX team forecast that the central bank will chide markets over excessive expectations Thursday. This would give the strategists the correction they are looking for.

Societe Generale is not the only bank this side of the Atlantic to have suggested, in recent days, there could be life in the old Dollar yet.

Strategists in the London office of Bank of America Merrill Lynch said Monday the EUR/USD rate could fall as far as 1.1500 over the first half of the year.

BAML says the move will be aided by US corporates sending Dollars back to the States in order to benefit from President Donald Trump’s one-time tax discount on offshore profits, although the EUR/USD rate is likely to return to its current 1.2230 level before year-end.

Readers can learn more about what other analysts say is in store for the EUR/USD rate this year from here; Compilation of Major Bank Forecasts, Currency Views for 2018.

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