Euro Fundamental Pickup Not Enough to Stem EUR/USD Slide

The Euro reached a new multi-decade low against the US dollar on Tuesday as the dollar recovered after a recent bout of profit-taking in the US currency. Despite flash-crashing to end 2016, the US currency has since regained its composure as US fundamentals remain strong despite the prospect of rising interest rates. Mirroring the more positive trajectory of economic activity in the United States, the Euro Area economy is also lifting off thanks to the central bank’s accommodative approach. However, the projections of a wider policy divergence over the coming year continue to weigh on EUR/USD, paving the way for parity in the pair in mere weeks or months.

Policy Positions Drive EUR/USD to Lowest Since 2003

Europe has been greeted with a myriad of good news since the outset of 2017. Starting out with manufacturing, expansionary momentum showed gains of acceleration, with the Euro Area aggregate PMI reaching a 5 ½ year high in December, according to a survey produced by Markit Economics.Besides German output rising to a 35-month high, even Greek manufacturing activity improved modestly, contracting at a tempered pace of 49.3 compared to 48.3 in November. Adding to the optimism has been German inflation, which increased by 1.70%, marking the fastest pace since 2013. While positive in the sense that it shows a rapid improvement inflation fundamentals, better traction in Germany does not necessarily reflect Euro-wide economic strength.

Harmonized inflation, which standardizes comparison across the Euro Area, shows that France is exhibiting markedly slow price rises. According to figures released on Tuesday by INSEE, French HICP inflation rose by 0.80% on an annualized basis through the end of December, less than half the comparable German figure. This unevenness could be a problematic point for policymakers, especially those eagerly looking to wind down asset purchases while awaiting the move off the zero bound for interest rates. As a result, there are numerous factors standing in the way of Euro appreciation. By comparison, the United States has seen broad-based improvements across the board, whether housing or manufacturing activity, paving the way for further dollar gains.

When measured against European economic activity, the future looks significantly brighter for the US.Figures released by the Institute for Supply Management pertaining to manufacturing showed growth in the sector at a 2-year high while construction spending, which is a strong leading indicator of economic health, hit a 10 ½ year high back in November. While financial markets are not necessarily as optimistic as the Fed when it comes to the projected path for interest rates, they still are currently pricing in two hikes for 2017 compared to none for the ECB. As a result, EUR/USD risks remain firmly skewed to the downside on the basis of monetary policy alone.

Technically Speaking

Although the Euro has since rebounded, EUR/USD hit new multi-decade lows on Tuesday, giving the impression that the most recent plunge is anything but over. Despite some sharp spikes higher during major fundamental events such as the US election, the last ECB decision, and a brief dollar flash-crash on December 30th, momentum has been predominantly lower, showing no signs of ebbing. For the better part of the last three months, the pair has been trending lower in bearish equidistant channel formation. After testing the upper channel line the final week of 2016, EUR/USD bounced off the level and is making its way towards the lower channel line.

Momentum indicators are lining up behind further downside in the EUR/USD pair, with both the Stochastic Oscillator and Relative Strength Index trending moderately above oversold levels. With neither above the 50.0, the downside for EUR/USD remains wide open. The key levels to watch are longer-term support sitting at 1.0410 and 1.0152. Any break below the second level presents a potential catalyst for EUR/USD to test parity at 1.0000. Beforehand, there may be a technical pullback higher over the near-term after recent momentum lower. However, standing in the way of any sustained rally are the 50-day and 200-day moving averages which are trending lower above the price action, presenting resistance near 1.0600 and 1.1000.

Looking Ahead

Although both the US and Euro Area economies are on a stronger trajectory thanks to ongoing accommodation, the projected divergence in interest rates will be enough to drive a deeper wedge between the two currencies over the medium-term. With momentum on the side of the US dollar for the foreseeable future, the EUR/USD is likely to remain under pressure, cratering towards parity of 1.0000 in the absence of a major fundamental development that shifts the relevant risk factors.Considering monetary policy is the primary factor contributing to momentum, the only major reversal higher may be a technical correction or a massive fundamental shift that change the underlying risks. However, absent such an event, risks remain skewed to the downside for EUR/USD.