Here’s What Decides

by Cliff Wachtel, FX Empire

FX Traders’ weekly EURUSD fundamental & technical outlook, and what makes this week potentially decisive for weeks to come

Summary

1. Technical Outlook: Near term neutral, longer term bearish
2. Fundamental Outlook a: Prior week’s drivers, lessons
3. Fundamental Outlook b: Coming week’s drivers, lessons, and what could bring a EURUSD reversal

EURUSD Weekly Technical Outlook: Bearish Momentum But Note That Bullish Hammer Candlestick

EURUSD Weekly Chart September 2, 2012 to Present
KEY: 10 Week EMA Dark Blue, 20 WEEK EMA Yellow, 50 WEEK EMA Red, 100 WEEK EMA Light Blue, 200 WEEK EMA Violet, DOUBLE BOLLINGER BANDS: Normal 2 Standard Deviations Green, 1 Standard Deviation Orange. Green downtrend line from EURUSD peak of July 2008 to present, green uptrend line from August 2012 to present. White Fibonacci retracement lines for downtrend of August 2008 To June 2010, yellow Fibonacci retracement lines for downtrend of May 2011 To July 2011.
Source: MetaQuotes Software Corp, www.fxempire.com, www.thesensibleguidetoforex.com

Key Points

The pair essentially held steady last week as a lack of material news in the short term provided no sustained push lower, while the very strong medium term downward momentum, prevented any meaningful bounce rally. To elaborate:

• As we predicted last week with our neutral short term forecast, the light economic calendar, aided by the mostly unchanged geopolitical landscape (scary potential, but no imminent threats) offered little fuel for additional downtrend. Indeed, the EURUSD’s modest net gain on the week reflected justifiable market indecision ahead of the coming loaded EURUSD event calendar.
• The fact that the pair remains in the extreme lower end of its double Bollinger® band sell zone means that strong downward momentum in the medium term remains, hence our medium term bearish outlook. As we see from the above chart, it limits any sustained upward potential in the absence of some very bullish EURUSD news. We may get some of that this week, see below for why in our fundamental analysis.

Technical Outlook Conclusion: Medium Term Bearish, Short Term Neutral

Given that persistent strong downward momentum backed by the equally persistent fundamentals behind (discussed in prior articles and in our fundamental analysis this week), the coming months should see the pair test lower.

In the short term, if this week’s events provide any excuse for further rallying, this week’s candle is a great big bullish hammer, and offers technical evidence suggesting potential for bullish follow through. The bullish hammer is more significant precisely when it follows a sustained, sharp downtrend like we’ve seen in the past eight weeks.

See our fundamental analysis below for more on the likely EURUSD drivers and how the pair could rally this week.

EURUSD Weekly Fundamental Outlook

Big EURUSD Fundamental Drivers, Lessons From Last Week

The USD rally continues, thus far more due to the fundamental problems of its primary counterpart, the EUR, (and to a lesser degree of its second and third most popular counterpart, the GBP and JPY) than the USD’s own fundamentals.

Continued threats of economic damage from exchanges of new economic sanctions between the West and Russia also contribute to the woes of the EUR and GBP, as Europe and the UK are more exposed to Russian trade damage than is the US.

Troubles in the USD’s chief trading counterparts include:

For The EUR

• Continuing Uncertainty On Size Of Coming ECB ABS Purchase Program Pressures EUR
• Continued Economic Underperformance Versus The US

For The GBP

Uncertainty Over Scottish Independence Threat Weakens GBP (EUR Too?)

• Increasingly close polls raise risk of Scotland voting for independence. We expect this vote on September 18th to fail as voters who might have voted in favor as a protest realize they might actually win and vote with their wallets, and the recognition that the economic harm would outweigh whatever mostly psychological benefits. A no vote, which we expect, should give the GBP a boost versus the USD and all other majors as that negative uncertainty lifts. A yes vote will pound the Pound much lower, potentially 10% lower per a recent Bloomberg poll.
• The ECB’s decision to ease gives the BoE a good reason to delay tightening for a number of reasons, another plus for the USD. For example, a falling EURGBP makes UK goods less competitive in their biggest export market, the EU.

For The JPY

Continued poor economic data, speculation on new, JPY-dilutive stimulus, from the BoJ

The big point from the above is that the USD’s continued gains in the near term may require continued bad news for 3 different currencies. That’s unlikely and by itself is not a stable recipe for continued EURUSD weakness.

The USD’s Own Fundamental Strengths

Ultimately the USD needs its own fundamentals to support further EURUSD downside. These include:

Rising US Rates: To some extent fed by sheer speculation on Fed policy, but meanwhile Fed policy will follow US economic performance. Last week didn’t have a lot, but it had was mostly good….

US Data: Highlights from last week include:

• Upward revisions to US Q2 GDP higher
• Improving retail sales, which support the story of an improving US jobs picture against naysayers who point to stagnant incomes. Not only did the August figures solidly beat forecasts, July figures were revised much higher.

See here for details.

This Week’s Top Potential EURUSD Market Movers

Wednesday October 17th FOMC Rate Statement, Forecasts, Press Conference

As usual the USD has driven forex flows in September, so the Fed’s meeting packs the most market moving potential not just for the EURUSD, but for currency markets as a whole.

The nine-week, 4.4% USD rally and the three-year high for US 2-year Treasury note yields implies markets expect the Fed to continue moving towards the end of stimulus and the start of rate hikes. Thus if the Fed fails to convey a more hawkish tone, the already overcrowded short EURUSD positions are like a wound spring primed to unwind fast.

There are a few ways this could happen. For example:

1. The Fed has long asserted that even after QE ends, it plans to hold rates steady for a “considerable time.” Dropping this phrasing, or replacing it with something implying a shorter period of steady rates would send a clear signal that the Fed is getting more hawkish.
2. Yellen sounds more hawkish at the press conference. For example, she’s more upbeat on the US economy, particularly on employment. Alternatively, she could make an outright admission that rates could rise sooner than previously planned (of course with the normal qualification that US data keeps improving).
3. Some other kind of clarification on when rates are due to rise that does not extend beyond the current consensus of mid-2015.
4. As the last Fed meeting of the quarter, it includes updated forecasts on employment, interest rates, and inflation. A bullish upgrade to this forecasts would favor USD bullish sentiment, as long as Yellen doesn’t downplay them in the press conference.

Conversely, doing the opposite of any of the above three moves, or even simply ambiguous, noncommittal comments, should send the USD down and the EURUSD higher. Given Yellen’s tendency to err on the dovish side, the odds favor this scenario and thus a EURUSD bounce in the wake of the Fed meeting.

Thursday September 18th ECB TLTRO Operation

The whole point of ECB’s recent rate cut was to prepare the way for strong demand for its TLTRO program by making it clear to banks that rates are now as low as they’ll go, thus banks should not wait for lower rates, and take full advantage of the program. The idea is to offer banks cheap loans on the condition that they use the funds for new loans and also pass on the low borrowing costs, fueling economic expansion and higher prices.

Thus the higher the demand, the better for the EU economy and the less likely it is that there will be further easing any time soon. Thus ironically, this seemingly EUR-dilutive program could actually boost the EUR as traders anticipate less future easing and perhaps a smaller ABS program.

Although there are other economic reports next week that could move the pair, the above two events are the big ones because they could set tone for the pair for weeks.

What Could Stop The EURUSD Rally? What To Monitor

In sum, to see continued bounce in the EURUSD, we’ll likely need to see:

• A Fed meeting that is more dovish than expected. Not only would this weaken USD demand, it would pump up general risk appetite, and that should boost the EUR.
• Strong TLTRO Demand

Other EURUSD Drivers To Monitor

Worth Noting: September 18th Scottish Independence Referendum

As long as polls stay close, this should continue to pressure the GBP and thus the EURUSD (via a weaker GBP’s support for the USD). As we expect the referendum to fail, the pair probably gets a boost once the results become known. The threat of Scottish independence is somehow seen as raising the risk of other European succession movements like that of Catalonia in Spain. So once this threat goes, the EUR might also get a boost. It follows that if the referendum succeeds, the USD would jump, and the EURUSD would slump.

We expect a no vote, and subsequent bounce in the GBP. The question is whether the EUR or USD suffers more from that sudden demand for the GBP.

Top Calendar Events To Watch

Beyond those mentioned above, here are the most likely scheduled events that could move the pair.

Monday

US: Empire state mfg index, capacity utilization rate, industrial production

Tuesday

EU: German ZEW sentiment report, EU ZEW report

US: PPI, TIC long term purchases

Wednesday

EU: Final CPI

US: CPI, FOMC Meeting, rate statement, forecasts, press conference

Thursday

EU: ECB TLTRO operation launch

US: Building permits, weekly new jobless claims, Fed Chair Yellen speech, Philly Fed mfg index

UK: Scottish independence vote

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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.