Although French bonds rallied on Monday after Moody’s decision to hold its credit rating unchanged instead of a downgrade, the pressure has since resumed. This was, after all, expected. So it wasn’t much a vote of confidence. Anyway, pressure remains on the EUR/USD ahead of this week’s central bank meetings. Both the Fed and ECB decided whether to hold fire or hike again. The current backdrop is modestly bearish. The EUR/USD is now down for the fifth consecutive day, albeit with only modest losses. Out of the past 8 weeks, the EUR/USD has fallen on 6 occasions. There are not much supporting factors for the single currency right now. So, the upside remains capped.
The French-German yield spread could widen further, while elevated oil prices continues to provide the biggest headwind. Unless something changes fundamentally, the risks to the EUR USD exchange rate remains tilted to the downside, and a visit of 1.1000 is still not out of question.
Dollar’s downside could be limited amid energy spike
Energy remains the bigger issue for the EUR/USD outlook. Oil prices climbed further higher last week and so far this week, they haven’t come back down much. Traders continued to price the risk of renewed US or Israeli action against Iran ahead of the US midterm elections.
As long as energy prices remain high, there is less scope for Treasury yields to fall significantly, which in turn limits the downside for the dollar.
At the same time, higher energy prices are weighing on the appeal of the euro and other currencies where the economy relies on energy imports.
ECB and FOMC rate decisions loom
The economic calendar this week is filled with central banks policy decisions. Among those, the FOMC is on Wednesday October 28. The recent risk off environment in stock markets and the drop in yields suggest markets have priced out a rate hike at this meeting. But the bar for markets to price out the prospect of a December Fed hike remains relatively high, which should limit the scope for a deeper USD correction. Comments from Warsh will be particularly important at this meeting.
The focus will then turn to the ECB rate decision a day later on Thursday, October 29. Despite growth indicators remaining relatively strong, some hawkish pressure on the European Central Bank is likely to persist especially with oil prices continuing to surge. However, the situation in France and weakness for both the euro and equity markets highlights the central bank’s dilemma. A hawkish hold might be the outcome at this meeting.
EUR/USD technical analysis
From a technical analysis point of view, the EUR/USD remains biased to the downside. This is because the currency pair has recently been under intense pressure.
Although over the last couple of weeks consolidation has been the name of the game, the fact that EUR/USD hasn’t been able to lift off suggests that the underlying selling pressure remains. As such, I wouldn’t be entirely surprised if we see a breakdown towards the 1.1000 handle in the next couple of days, particularly if the Fed turns out to be more hawkish than expected on Wednesday.
The initial downside target is the mid-October low which comes in around 1.1113.
On the upside, key resistance has held around the 1.1250 area last week, leading to a break below 1.1200. The latter is now the initial resistance to watch. But a potential break above these levels could pave the way for a move towards the larger resistance band between 1.1300 and 1.1350.
That’s where EUR/USD had previously found support in June before breaking lower in late September.
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