EURUSD Weekly Fundamental Outlook: Market Drivers, Lessons for This Week
FX Traders’ weekly EURUSD fundamental outlook, prior week’s lessons to remember and this week’s market drivers to monitor
The following is a partial summary of the conclusions from the fxempire.com weekly analysts’ meeting in which we cover outlooks for the major pairs for the coming week and beyond.
- Technical Outlook: Accelerating deterioration of support, momentum. See here for details.
- Fundamental Outlook 1: Market drivers and lessons- a daily breakdown
- Fundamental Outlook 2: Ukraine, data gap, rate expectations gap all favoring USD over EUR
- Fundamental Outlook 3. Longer Term Considerations
- Fundamental Outlook 4: Likely market drivers to watch for the coming week and key questions
See here for a combined technical and fundamental weekly outlook for the EURUSD
Fundamental Outlook: What Drove The EURUSD – Daily Breakdown And Lessons
Daily Breakdown And Lessons
The EURUSD fell solidly for the first three trading days of the week. Why? In essence, a combination of continued better US data or EU weakness, a surprise change of tone in FOMC meeting minutes, and concerns about escalating military and economic sanctions activity, to which the EU is far more exposed.
There was no obviously market moving top tier news for the US or EU, other than perhaps a miss from EU trade balance and a beat from US NAHB housing market index. Most likely the decline was due to a combination of this data, and both the concerns about military escalations in Ukraine over the weekend as well as the continued effects of recent week’s poor GDP and PMI readings from the EU.
The day’s calendar events again highlighted the “data gap” between the EU and US. Europe’s current account came in under forecasts, as did a batch of UK inflation data. Meanwhile, US building permits and housing starts beat both forecasts and prior month readings. Inflation was low but in line with forecasts. The housing figures also reinforced the effect of Monday’s NAHB housing index, solidifying the message that July was a good month for the critical US housing industry. It’s worth repeating that the US economy is of course more focused on domestic spending and financial services than other economies, and housing related spending is a huge supporter of both of these critical sectors.
The Fed had recently expressed concern about the US housing sector, however Monday and Tuesday’s uniformly upbeat data fed the pro-USD consensus that the Fed will indeed feel ready to end QE in October.
Wednesday: There’s Nothing Like A Change In Central Bank Tone To Move A Currency
Here we had the climactic largest EURUSD drop for the week. It’s important to be aware of the context in which it occurred. Tuesday’s close broke decisively below the 1.335 level, which had been reliable support since the start of August on the daily charts, and also moved the pair firmly back into its multi-month descending channel. That technical breakdown alone surely tempted short term traders to add short positions and ride the once again accelerating short term downtrend.
So with traders already open to adding to an already crowded short positioning, a surprisingly hawkish flavor to the FOMC minutes was both catalyst and fuel for the week’s biggest daily decline. Highlights for the July 29-30 transcript included:
- On employment: “Many Fed officials” thought that the pace of job gains could accelerate the time of the first interest rate hike.
- On Inflation: “most” believed downside pressures on price growth was fading.
While the above gives no specific date for the first 25bp hike, it does present a clearly hawkish tone that supports the consensus belief that it will come between Q4 2014 and mid-to-late 2015.
In a world where markets are now dominated more than ever by speculation about central bank policy, nothing moves a currency like an event that alters expectations about the pace and extent of a policy change, so it’s no huge surprise that the normally predictable FOMC meeting minutes’ hawkish surprise boosted the USD and drove the pair all the way down to its next major support level, even after it had just broken significant through 2-week old support.
Thursday: EURUSD Bounce As Fear of Yellen Dovishness Overrides Good US Data Weak EZ PMIs
As we saw Monday and Tuesday, once again US data’s uniformly positive, forecast beating results stood in contrast to middling-to-weak EU reports. Yet the EURUSD bounced for its only daily gain of the week.
Although at first glance this is baffling, and we didn’t anticipate it, there was a definite logic to the day’s results that is instructive for the future.
The short term traders that dominate EURUSD volume are by nature heavily focused on technical support/resistance levels and positioning. The role of the trader is first and foremost to predict what the herd will do and do it first, regardless of whether that behavior seems particularly rational or not.
The pair had not only plunged hard for 3 straight days, but also Wednesday’s close it had brought the EURUSD all the way down to its next major support indicator, the 38.2% Fibonacci retracement near the 1.335 level. The pair was also oversold on a short term basis by a variety of technical momentum indicators.
So traders were ready to go long (or take profits on shorts) if given any excuse. Janet Yellen’s well-known dovishness and resistance to altering dovish Fed policy based on single-month data points (she makes decisions based on longer term data trends formed over months, not weeks) suggested that ahead of her Friday Jackson Hole speech, some profit taking would be prudent.
After all, the past three days’ declines had already priced in a lot of bullish expectations for the USD. It seemed unlikely that either Yellen, or Draghi, could provide enough of a EURUSD bearish surprise to inspire a selloff strong enough to drive the pair decisively below the 1.335 level on its first try.
- –The Fed is already due to end QE in October, the US recovery is far from robust, inflation is dead, and so there was no reason to suspect Yellen to feed expectations for faster tightening, especially given her well known caution and preference to err on the side of tightening later, just like predecessor Ben Bernanke.
- –Meanwhile, while the EU’s PMIs were uninspiring, Germany and France weren’t as bad as expected, with flash services PMIs for Germany and France actually beating forecasts. The ECB still hasn’t had enough time to evaluate its prior easing measures, and with Germany and France looking a bit better, there was nothing to suspect Draghi will rush in new easing.
A Valuable Reminder Lesson For Understanding Forex Price Movements
In short, the lesson from Thursday is this. As long as forex continues to be dominated by short term traders, daily forex price moves will be dominated by short term (24 hours or less) considerations. As I discuss at length in my book, primary among these are key technical and positioning considerations, as well as a professional (as opposed to the typical retail amateur) short term trader’s focus on short term risk management, which is also based on these technical and positioning factors.
Friday: Rising Ukraine Tensions, Less Dovish Yellen Speech, Drive Selloff
As noted above, the profit taking on Thursday indicated that traders were being cautious and sold the USD (thus boosting the EURUSD) in preparation for a dovish speech. After all, Yellen has consistently shown she’d rather err on the side of caution and tighten too late rather than too early, so there was a good chance she would downplay the recent improvements in U.S. data along with FOMC debates over of an earlier rate rise at the last central bank meeting.
Contrary to those expectations, however, she gave a more balanced approach that was thus, relatively, more hawkish than expected because she didn’t rule out the chance of a more hawkish tone at next month’s Fed meeting. Yellen confirmed that asset purchases will end in October and indicated that if jobs data improved faster, that could bring an earlier rate hike. This key line would have boosted the USD and sent the EURUSD down further if she hadn’t immediately added that slower jobs data improvements could delay a rate increase.
ECB President Draghi’s speech offered nothing new and thus did nothing to counteract the bullish USD reaction that sent the EURUSD lower.
Note that continued escalation of Ukraine tensions also contributed to the Friday selloff, and had the pair down hard early in the day before it attempted to bounce ahead of those speeches. The result was a technically damaging, very bearish close at 1.32420, below the key support of the 38.2% Fibonacci retracement level of the May 2012 EURUSD rally around 1.3250.
Conclusions, Lessons: Top Fundamental Drivers Of The Week’s Big EURUSD Selloff?
It’s too early to call this penetration an actual breakdown of this support level. However we can say the 1.3330 level, which had held consistently after 3 weeks of tests, is now decisively broken.
Ultimately, the week’s big EURUSD fundamental drivers were:
- –Rising risks of economic damage from escalating Ukraine tensions from Russia’s “humanitarian” convoy into Ukrainian territory without the consent of Ukrainian authorities, which they correctly labeled as a “direct invasion.”
- –Strengthening of the ‘data gap’ between improving US economic data and deteriorating EU figures, which feed conviction about an ultimate, enduring USD interest rate advantage with the coming year.
- Rising expectations about the pace and timing of a Fed rate hike, fueled by:
- –A more hawkish FOMC meeting minutes that solidified expectations that the first 25 bps hike comes within the next 12 months
- –A modestly less dovish Yellen speech that didn’t counter that impression.
All of the above helped buttress expectations for both near term USD gains versus the EUR and for a sustained USD rate advantage within the coming year.
Other Key Lessons: Longer Term Drivers
Here we focus on longer term concerns.
Europe’s economy is struggling even before the current round of economic sanctions take effect. Given the recent Russian invasion by a purportedly humanitarian Russian aid convoy, a new round of economic sanctions against Russia, and Russian counter-sanctions is coming. Russian trade is a bigger portion of Europe’s GDP and so these hurt the EUR more than the USD.
Italian sovereign debt is unsustainable and presents the biggest risk of starting the next EU debt crisis. Edward Hugh had a great piece out last week on the likely catalyst for the next phase of the EU debt and banking crisis. He details how Italy’s debt levels are both unsustainable and unlikely to shrink in the years ahead. Unlike the debt of Greece or Portugal, Italy’s sovereign debt is too large to be resolved with more extend and pretend programs of lending more printed money. Although markets continue to believe ECB President Draghi can and will ultimately prevent a new crisis, it’s just a matter of time before bond markets realize that he can’t. Stay tuned for more on this in our coming post on the next phase of the EU crisis and how to spot its coming. Note, although Hugh focuses on Italy, we could easily see the same thing from Spain.
The EU’s biggest mistake and what has actually preserved it thus far. Ok, I mean “biggest mistake” after allowing so many member states to take on too much debt. Joe Weisenthal argues here that austerity was a huge mistake, the EU’s lack of a central bank that can print as much money as needed is the key weakness of the EU which prevents its long term stabilization. Draghi’s promise in 2012 to do whatever it takes was a bluff that attempted to suggest that power, but he doesn’t have it.
Coming Week Likely Top Market Movers To Watch
- Continued Ukraine escalation. See our coming post on top lesson and market movers for the coming week.
- Top economic calendar events highlighted below. As mentioned in earlier posts, EU data is more important at this stage because the ECB’s policy is still in flux, with more easing a matter of when, not if.
- Technical support levels. While last week’s close was not far enough below the 38.2% Fibonacci retracement of the May 2012 rally around 1.3250 to call this support broken just yet, further declines should tempt traders to test the next big support indicator, the lower edge of the pair’s descending channel around 1.3176 shown in the above weekly EURUSD chart, especially if the above mentioned fundamental drivers of last week (Ukraine tensions, US-Europe data gap) persist.
Top Calendar Events To Watch
Top tier events with the most market moving potential are shown in boldface
EU: German Ifo business climate
US: flash services PMI, new home sales
US: Durable goods m/m, S&P/Case Shiller composite 20 HPI y/y, CB consumer confidence
Wednesday: No likely market moving reports scheduled
EU: German, Spain preliminary CPI m/m, Italy 10 year bond auction
US: Preliminary GDP q/q, weekly new jobless claims, pending home sales m/m
EU: German retail sales, EU PI flash estimate y/y
US: Core PCE price index m/m, personal spending, income, m/m, Chicago PMI, revised UoM consumer sentiment
Biggest Questions & What To Watch To Answer Them
Will Russia continue escalating its Ukraine invasion?
Will data continue to show the US economy pulling away from the EU? If so, is that improvement enough to justify rising expectations about the scope and pace of Fed tightening?
Sample Retail Traders Positioning
Once again, our real time sample of retail traders continue to attempt to fade the current EURUSD trend rather than ride it. They remain a group worth watching, because doing the opposite has proven profitable since the start of July.
01 Aug. 23 23.44
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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.