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EUR/USD Erases FOMC Driven Gain as ECB Warns of Euro Area Recession

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EUR/USD Rate Talking Points

EUR/USD gives back the advance following the Federal Reserve interest rate decision as European Central Bank President Christine Lagarde warns that the Euro Area “is likely to contract again in the first quarter of the year after declining by 0.7 per cent in the fourth quarter of 2020,” but the exchange rate may continue to track the March range as it manages to hold above the 200-Day SMA (1.1843).

EUR/USD Erases FOMC Driven Gain as ECB Warns of Euro Area Recession

Recent developments coming out of the ECB appear to be dragging on EUR/USD as the central bank steps up the pace of the pandemic emergency purchase programme (PEPP), and recent remarks from President Lagarde suggest the Governing Council is in no rush to alter the path for monetary policy even though European authorities prepare to distribute the Next Generation EU recovery fund in 2021.

During the testimony in front of the Committee on Economic and Monetary Affairs of the European Parliament, President Lagarde emphasized that the “economic outlook for the euro area remains surrounded by uncertainty due to the dynamics of the pandemic and the speed of vaccination campaigns,” with the central bank head warning of a technical recession as GDP is now expected to contract for two consecutive quarters.

Nevertheless, President Lagarde went onto say that “the ongoing vaccination campaigns, together with the gradual relaxation of containment measures underpin expectation of a firm rebound in economic activity in the second half of 2021,” but it seems as though the Governing Council will continue to utilize its emergency measures to support the Euro Area as “purchases under the PEPP over the next quarter to be conducted at a significantly higher pace than during the first months of this year.

In turn, the Euro may face headwinds ahead of the next ECB interest rate decision on April 22 as President Lagarde pledges to “monitor developments in the exchange rate regarding their possible implications for the medium-term inflation outlook,” with the recent weakness EUR/USD generating a flip in retail sentiment as traders turn net-long the pair for the fifth time in 2021.

Image of IG Client Sentiment for EUR/USD rate

The IG Client Sentiment report shows 51.89% of traders are currently net-long EUR/USD, with the ratio of traders long to short standing at 1.08 to 1.

The number of traders net-long is 14.70% higher than yesterday and 14.41% higher from last week, while the number of traders net-short is 7.97% lower than yesterday and 0.77% higher from last week. The rise in net-long position appears to have fueled the shift in retail sentiment as 45.55% of traders were net-long EUR/USD earlier this week, while the marginal increase in net-short interest comes as the exchange rate gives back the advance following the Fed rate decision.

It remains to be seen if the crowding behavior from 2020 will resurface as Chairman Jerome Powell and Co. see the benchmark interest rate sitting near zero through 2023, and the shift in retail sentiment will be short-lived like the behavior seen earlier this year.

With that said, key market themes may continue to influence EUR/USD as the US Dollar still reflects an inverse relationship with investor confidence, and the decline from the January high (1.2350) may turn out to be a correction in the broader trend rather than a change in behavior as the exchange rate holds above the 200-Day SMA (1.1843).

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EUR/USD Rate Daily Chart

Image EUR/USD rate daily chart

Source: Trading View

  • Keep in mind, the EUR/USDcorrection from the September high (1.2011) proved to be an exhaustion in the bullish price action rather than a change in trend following the string of failed attempts to close below the 1.1600 (61.8% expansion) to 1.1640 (23.6% expansion) region, with the Relative Strength Index (RSI) reflecting a similar dynamic as the oscillator broke out of the downward trend to recover from its lowest readings since March.
  • However, EUR/USD appears to have reversed course following the failed attempt to test the April 2018 high (1.2414), with the exchange rate extending the decline from the January high (1.2350) as it struggled to push back above the 50-Day SMA (1.2064).
  • The 50-Day SMA (1.2064) appears to be developing a negative slope as EUR/USD trades to a fresh yearlylow (1.1836) in March, but the exchange rate may continue to track the monthly range amid the string of failed attempts to test the 200-Day SMA (1.1843).
  • Need a move back above the 1.1920 (78.6% expansion) to bring the 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion) region on the radar, with the next area of interest coming in around 1.2010 (100% expansion).
  • However, a break/close below 1.1860 (61.8% expansion) opens up the 1.1760 (38.2% expansion) area, with the next region of interest coming in around 1.1700 (23.6% expansion) to 1.1710 (61.8% retracement).

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— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong



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