EUR/USD Between a Rock and a Hard Place

The dominant narrative thus far has been that of the reflation trade, complete with expectations of dollar weakness into and throughout 2021. This saw the euro appreciating against the US dollar by more than 16% between its lows last March and the highs it set early in January before retracing.

However, any slight shift in sentiment from that strong reflation trade narrative is being felt across the asset spectrum. We’re seeing this in US equities, with the recent sell-off affecting Russell 2000 stocks in a much more pronounced manner than the tech names of the Nasdaq. We’ve also observed it in the recent bout of profit-taking in crude oil that saw it dipping below the 20-day moving average for the first time since November. All this has contributed to dollar strength and perhaps most notably to the first break below the 20-week moving average in the EURUSD pair earlier this month since all the way back to the depths of the Covid crash last March.

What’s Weighing on the Euro

The euro’s upward march against the greenback is being stifled by a number of factors besides the shifting sentiment around the consensus of global reflation. For one, Europe is lagging behind both the United States and the United Kingdom in its ability to mass vaccinate the populations of its individual member nations. This due to a combination of vaccine skepticism, shortages and concerns over the British-Swedish AstraZeneca vaccine. Hungary, which currently boasts the most successful vaccination roll-out in Europe, has resorted to importing the Russian Sputnik V vaccine, despite it not yet being approved for use in Europe.

Furthermore, the distressing possibility of a third wave of coronavirus infections appears to be turning into a reality, with the seven-day incidence rate in Europe having jumped by 40% since February. It now appears that France, Italy and Germany will all be entering strict Easter lockdowns in order to curb the spread of the virus.

Beyond the pandemic, Turkish President Erdogan’s recent sacking of central bank president Naci Agbal, his third such firing in two years, has caused the Turkish lira to tumble yet again. This too, has important knock-on effects for Europe. Firstly, it impedes Turkey’s ability to repay European banks, which are among Turkey’s debtors. Second, a falling lira diminishes the purchasing power of the Turkish populace, and with it their appetites for imported goods from its European trading partners, which it has historically stronger ties with than the United States.

A Return to Dollar Strength?

A risk-off mood, hastened, as we mentioned above, by the sheer overcrowding of the reflation trade, is leading to a return of dollar strength. You can view this in a purely technical light, with investors booking their profits from everything reflation in US dollars. Whether it be the outsized gains of US equities, or the surge in commodity prices we’ve been witnessing, you can understand the urge to take some profits off the table at these highs.

Then there are the many fundamental reasons for them wanting to hedge against the consensus of reflation, particularly with Europe’s own recovery now starting to look a quite shaky. These alone account for some of the strength in the greenback we’ve been witnessing of late. Add to this Jerome Powell’s recent failure to allay the market’s fears over rising bond yields, as well as Janet Yellen’s recent testimony to US lawmakers where she hinted that “some revenue raisers” (which the market has read as tax hikes) would be required to offset the cost of the Biden administration’s forthcoming $3 trillion infrastructure spending plan, and you can see why US dollars are starting to look like a good bet for many investors.

Technically Speaking

EURUSD has been gearing up to retest the recent lows it set at 1.183 on March 9. March 23 saw it returning to those lows after a failed break above 1.198 on March 11 and March 17. We’ve been observing the same action mirrored in the DXY, with a retest of 92.5 after a failure to close below 91.35. And again, in the EXY as it returns to test 118.4after failing to break beyond 119.9.

At the time of writing, that EXY level at 118.4 has yet to break, however, the opening of the European trading session on March 24 has seen the euro breaking below 1.183. Whether this is a temporary fake-out remains to be seen. Those of you observing RSI levels will be interested to note that a 4-hour divergence is forming between the price action and RSI. RSI dipped to 19.59 on March 9 when EURUSD dropped to 1.183 and is now sitting around 29.7 despite the price having made a lower-low at 1.182. This could be evidence that the move down is showing signs of losing strength, which could lead to a bounce from here. However, the broader market outlook remains bearish for EURUSD so even in the event of a bounce, keep an eye out for a lower-high below 1.194 to be set from here.

by Giles Coghlan, Chief Currency Analyst, HYCM

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