Trade Of The Week: EURUSD Poised To Settle Below Parity?

If you are not already keeping a close eye on the euro, then what are you waiting for?

The currency hijacked market headlines last week after hitting parity for the first time in 20 years!

After dipping as low as 0.9952, it looks like euro bulls are making a desperate attempt to drive prices out of the parity zone where bears prowl. Nevertheless, the euro remains under the mercy of various fundamental forces with the widening policy divergence between the Fed and ECB fuelling the downside momentum. When factoring how the daily, weekly, and monthly timeframe favour bears – EURUSD bulls certainly have a steep hill to climb.

Briefly looking at the fundamentals, the growth picture for Europe looks bleak. Inflation continues to soar while the war in Ukraine has created political and economic uncertainty – further dampening the outlook. With the euro shedding almost 12% against the dollar year-to-date, this will push up the relative price of oil which is trading in dollars – ultimately feeding the inflation beast.

With prices rebounding from parity, the key question is whether the current move is a solid rally to higher levels or just a dead cat bounce?

A dead cat bounce is a short-term recovery in a declining trend that does not indicate a reversal of a bearish trend. - Source Investopedia

The low-down…

Last week, the euro was attacked from all directions.

Political drama in Italy, a broadly stronger dollar, and rising geopolitical risks among other key themes haunted investor attraction towards the currency.

The widening policy divergence between the Fed and ECB was the cherry on the cake for EURUSD bears, making the parity dream reality. However, bulls and bears were entangled in a fierce tug of war around this level with strong support around 1.000. Even though prices traded as low as 0.9952, the EURUSD concluded the week above parity.

Without digging too deep into the derivative markets, the reason why the EURUSD was initially hesitant to break 1.000 was based on options. To add more colour, imagine the EURUSD being defended at parity by traders doing everything in their power from having to pay on financial contracts if the level is crossed. For more information on options please click here.

What to expect in the week ahead...

Investors will direct their attention toward the final annual inflation rate in the Euro Area scheduled to be released on Tuesday. The report should confirm that inflation increased to a record high of 8.6% in June, topping market expectations of 8.4% and reinforcing the case for the ECB’s first rate hike in 11 years.

All eyes will be on the European Central Bank (ECB) rate decision and ECB President Christine Lagarde’s press conference on Thursday. The ECB is expected to raise interest rates for the first time since 2011 with markets pricing in a 25-basis point move. However, this would keep rates in the Eurozone still in negative territory despite inflation soaring to a record high of 8.6% according to preliminary estimates.

Given how the 25-basis point rate hike is unlikely to turn the euro’s fortunes around anytime soon, much attention will be directed towards Christine Lagarde and the ECB’s anti-fragmentation policy tool plans. If the ECB’s anti-fragmentation policy tool plans disappoint, Lagarde’s press conference underwhelms and/or political uncertainty in Italy intensifies – the euro could weaken back towards parity and lower. Alternatively, a surprise 50bps rate hike, firmly hawkish Lagarde and a positive reaction to the bloc’s new tool to keep bond yields from soaring too high could support euro bulls.

Regardless of what decision is made by the ECB, it remains in a tricky position. If the central bank lets the euro weaken further – this could fuel inflationary pressures but fighting back by raising interest rates may punish an economy already facing a possible recession. Whatever happens on Thursday, it could have a lasting impact on the euro.

EURUSD to settle below parity?

The fundamentals and technicals remain in favour of euro bears. Prices are under pressure on the monthly, weekly, and daily timeframe.

On the monthly timeframe, the path of least resistance points south as there have been consistently lower lows and lower highs. The candlesticks are trading below the 50, 100, and 200-month Simple Moving Average while the MACD trades to the downside. However, the RSI has hit oversold regions – signalling a potential rebound before bears return to the scene.

On the weekly charts, it’s the same story. There have been consistently lower lows and lower highs while the MACD is trading below zero. Prices are approaching the 1.0200 level which could act as a firm resistance. Should this level defend against bulls, prices could sink back towards parity. A breakout above 1.0200 may signal a move back towards 1.0400.

Things are looking interesting on the daily charts with 1.0200 acting as the first level of interest. Above this point, the next checkpoint can be found at 1.0350 and 1.0480. If the upside momentum fizzles out below 1.0200, a decline back towards 1.0000 and 0.9900 could be on the cards.

ECB EURUSD Federal Reserve inflation Rates