The prospect of US rates rising in May, and manoeuvres by the Fed to wind up its asset-purchase program will impact currency markets. In particular, we could see the EUR/USD fall into the low 1.30 region later this year.
Chris Weston, chief market strategist with IG, says it hinges on whether the dovish and easing sentiment iterated by most central banks stays on script. Plus, we’d want to see better economic growth in the developed world; and China growth of around 7.5%.
The EUR fell prey to conjecture that the US would raise rates to 1% in 2015. Having now laid the ground work for rate hikes, Weston expects the USD to be super sensitive to tier-one data from here; it will act more than ever as a pro-cyclical currency.
The jury is still out on whether a stronger sell-off in EUR/USD is looming and whether a move below 1.3800 represents a buying opportunity. The fact that the EUR/USD fell to 1.3749, but then subsequently rallied, and for now seems to be holding the 38.2% retracement of the recent February to March rally at 1.3878, is positive.
However, Weston says the bulls will want to see this retracement as a platform from which to advance and close above the multi-year downtrend at 1.3815 (as shown on the chart below). He says a close back above 1.3815 would reveal much about the psychology of traders, especially within a tough FX trading environment where nothing is trending too well, and every time a consensus trade kicks-in, the dynamics change and the market has to alter course.
“Fundamentally I like the pair lower over for the rest of the year, but the big trading opportunity seems to be passing us now that the Fed has provided the market with a more hawkish backdrop,” says Weston.
While tapering was pretty much a given and already priced in, many participants were caught unawares by the unexpected hawkish nature of Fed Chair Lady Yellen’s speech.
The USD Index is now trading up around a 3-week high. Matt Simpson, market analyst with TF Global Markets, expects to see the Index trade up to 80.50, which should see the EUR/USD trade down to 1.3725 area.
This is expected to keep EUR/USD from moving materially past 1.40 which was within grasp before the reversal and eventual bearish close. What makes this particular candle of interest, adds Simpson, is the volatility – which when coupled with heavy volume – makes it a likely candidate to be a reversal for the near-term. “1.40 is not out of the question, but near-term is struggling to get up there. We broke out of a bullish channel last week and current price action appears to be corrective,” says Simpson.
“For now, my bias is a break below recent lows and the 1.3835 support to target 1.3780 support zone – a break below the bullish channel – would warn of a much deeper pullback and to target 1.370.”
Had the Fed not revealed the possibility of raising rates in May – with the EUR/USD continuing to gravitate towards 1.45 – the prospects of the ECB acting more aggressively would increase, notes Weston. “This in theory could have meant unsterilised bond purchases, or quantitative easing as we know it. The prospect of extreme volatility in the EUR would have been very appealing to short-term traders,” Weston adds.
Interestingly, the Fed managed to achieve what the ECB clearly can’t, namely weaken the EUR/USD. Nevertheless, given the outperformance of peripheral bond and equity markets – driven by strong earnings per share expectations for European stocks relative to the US market, plus Europe’s current account surplus – Weston says the market has little reason to be overly bearish on the pair.
Meantime, with the GBP/AUD also looking vulnerable, Weston would certainly be trading this pair from the short side, despite the fundamentals being fairly neutral right now. The fact the BoE is likely to hike in Q1 is naturally bullish for the pound. But with expected moves from the bank already priced in, he says it’s hard to see the market becoming more aggressive with its pricing structure than it already is.
Assuming FX markets are largely moving on inflation forces, Weston says a move in the UK below 1.7% should push GBP/AUD convincingly lower, especially with inflation in Australia being at such levels that the RBA would be looking at rate hikes than cuts. “Technically the pair is a sell, the neckline of the multi-month head and shoulders pattern has been breached and a subsequent close below the January 15 low of 1.8015 would clearly see the selling accelerate,” says Weston.