Fundamentals: Dovish ECB to send the euro lower
The EUR/USD pair continued to trade in a narrow range last week as markets’ focus shifted towards the July ECB meeting. Once considered a non-event, the is about to unveil a new monetary strategy, with market expectations set for a dovish shift. The bank has previously announced that the PEPP will run at least to March 2022 and adopted a new target from “below, but close to 2%” to “2%”, which, itself, somewhat dampened expectations of earlier policy normalization.
Over the Atlantic, Fed’s Powell tried to reassure markets that is only transitory, providing the example of the rise and fall of lumber prices as something the Fed would like to see more of. Still, Powell’s testimony was not enough to trigger a recovery in global risk appetite, although the last week’s risk correction seems somewhat overextended.
The fall in US Treasury yields, combined with a quiet week in the United States data-wise, could see a weakening US dollar in the coming week. However, a dovish ECB and elevated risk aversion (which is my base-case scenario) could still send the EUR/USD pair lower (while providing support to other cyclical currencies).
Upcoming Market Reports:
Wednesday at 14:30: USD Crude Oil Inventories (Previous: -7.9M)
Thursday at 11:45: EUR Statement
Thursday at 11:45: EUR Main Refinancing Rate (Expected: 0.00%, Previous: 0.00%)
Thursday at 12:30: USD Unemployment Claims (Expected: 350K, Previous: 360K)
Thursday at 12:30: EUR ECB Press Conference
Friday at 07:15: EUR French Flash Manufacturing PMI (Expected: 58.1, Previous: 58.6)
Friday at 07:15: EUR French Flash Services PMI (Expected: 58.7, Previous: 57.4)
Friday at 07:30: EUR German Flash Manufacturing PMI (Expected: 64.2, Previous: 64.9)
Friday at 07:30: EUR German Flash Services PMI (Expected: 59.4, Previous: 58.1)
Friday at 08:00: EUR Flash Manufacturing PMI (Expected: 62.6, Previous: 63.1)
Friday at 08:00: EUR Flash Services PMI (Expected: 59.4, Previous: 58.0)
Friday at 13:45: USD Flash Manufacturing PMI (Expected: 62.0, Previous: 62.6)
Friday at 13:45: USD Flash Services PMI (Expected: 64.6, Previous: 64.8)
Looking at the 2-year yield differential between US Treasuries and German bunds, it’s obvious that the recent slide in UST yields caused a spike to the upside, forming a potential . However, EUR/USD doesn’t seem to care much as the USD remained supported on risk aversion this morning. Soaring covid cases worldwide are a threat for global risk sentiment, which in combination with the ECB meeting, is a double sign for EUR/USD .
Another argument in favor of further downside in EUR/USD is the US dollar index . DXY reached the highest level in almost four months, despite falling yields across the US yield curve. The 92.80 level acts now as an important support for the DXY , followed by the 92.50 level (61.8% Fib), and 92.10 (weekly lows).
Sentiment: USD short-covering continues, putting upside pressure on the currency
The latest report shows a sharp fall in USD short positions, with the aggregate short more than halving to just $3.6 billion. This is the smallest net short positioning since March. Most of the USD short-covering came from the euro . The net long positioning in the single currency tumbled by $2.6 billion, mostly as a result of more short positions in the currency.
EUR/USD risk reversals, as of last Friday, show that put options are becoming relatively more expensive compared to similar out-of-the-money call options, which signals that investors are increasingly preparing for further weakness in the EUR/USD pair. This is especially true for options expiring this week.
In the FX market, risk reversals refer to the difference between the implied of the most popular out-of-the-money calls and puts with the same expiration. Higher demand for an options contract increased its and price. Therefore, a positive risk reversal signals that upside protection in the pair is relatively more expensive than downside protection, suggesting that investors are speculating on a rise in the currency.
Technicals: Bears eye the 1.17 level
From a technical standpoint, the EUR/USD pair continues trading in a slight downtrend, with the range of the last two weeks likely acting as a accumulation phase. The 61.8% Fib level keeps holding, forming a rather strong in the upper 1.18 area. This area aligns with a previous fake breakout and the post-FOMC dollar slide and is very likely to attract strong selling pressure in case the pair makes it to those levels.
This morning, the pair broke below last Friday’s range and was last seen trading at 1.1785. The new structure, in combination with increasing and wider open-close ranges, signals a higher supply of the pair and the potential for a break below the all-important 1.1770 monthly support.
I am on EUR/USD this week, based on market sentiment, positioning ahead of the ECB meeting, and elevated risk aversion. The PoC near the 1.1810 level (the level with the most traded on Friday) could be used for bears to enter into an attractive risk-reward trade.
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