Euro – Headed for 1.25? Outlook and Levels

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The recent rally in the U.S. dollar has taken the greenback to fresh highs against many of the major currencies. The euro and British pound are now trading within a cent of their year to date lows, while the Australian dollar is hovering above 90 cents. The Japanese Yen still has room to fall before reaching its next major resistance at its 4 year high above 103, but given last week’s developments, particularly in Europe, we believe it should only be a matter of time before these resistance levels are broken. Europe pledged to provide easy money for the foreseeable future with the Bank of England being surprisingly aggressive. The recent volatility in the short terms rates made central bankers in the region uneasy while uneven growth justifies the need for continued stimulus. With the European Central Bank and the Bank of England going out of their way to stress their dovish monetary policy bias and the Bank of Japan considering increasing the frequency of asset purchases this week, the Federal Reserve is on a solitary path to reduce stimulus. On this basis alone, we expect the dollar to continue to rise especially given the newfound dovish-ness from the BoE and possibly the BoJ this week.

The focus should be on yields. As our colleague Boris Schlossberg pointed out this morning, the spread between 10 year U.S. Treasury and German Bund yields hit a 7 year high last week. The chart below compares the inverse of this spread (Bund-Treasury) with the performance of the EUR/USD and suggests that given the speed and magnitude of the decline in the spread, the EUR/USD should be trading much lower. While the spread between UK and US yields also dropped to its lowest level since 2006, the GBP/USD has kept track with the magnitude and speed of the sell-off.

Taking a look at shorter-term charts, the April low of 1.2746 is near term support for the EUR/USD but if we expand to the monthly chart, a series of lower peaks can be seen with a base near 1.2050. Of course, there’s a long way to go before that level is reached and the currency pair will mostly pause at 1.25 but the technical structure points to further losses once the EUR/USD drops below 1.2746. Below 1.25, the next major support level that we will be watching is the 50% Fibonacci retracement of the 2000-2008 rally that took the pair from a low of 0.8230 to a high of 1.6038.

While USD/JPY will be in play this week with the Bank of Japan rate decision on the calendar, the FOMC minutes and Eurozone data will keep the EUR/USD in center focus. If the minutes from the last meeting reveal significant consensus behind a move to taper in September, the EUR/USD could break its current year to date and head towards 1.25.

Kathy Lien
Managing Director

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