EUR/USD Stages Four Day Rally as ECB Adopts Hawkish Tone Ahead of NFP

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EUR/USD Rate Talking Points

EUR/USD stages a four-day rally as European Central Bank (ECB) officials adopt a hawkish tone, but the update to the US Non-Farm Payrolls (NFP) report may undermine the recent recovery in the exchange rate as the Federal Reserve looks poised to switch gears later this year.

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EUR/USD Stages Four Day Rally as ECB Adopts Hawkish Tone Ahead of NFP

EUR/USD trades back above the 50-Day (1.1806) for the first time since June as ECB Vice-President Luis de Guindos anticipates the Euro Area recovery “to be fairly strong in the third and fourth quarters,” and the comments suggests the Governing Council will adjust the forward guidance over the coming months as the “European economy will be able to recover its pre-pandemic income levels by the end of this year or the beginning of next year.”

As a result, Vice-President Guindos insists that “if inflation and the economy recover, then there will logically be a gradual normalisation of monetary policy,” but went onto say that “the premature withdrawal of stimulus should be avoided” during an interview with El Confidencial.

It seems as though the ECB is in no rush to alter the path for monetary policy “given that the economic situation is still fragile,” and it remains to be seen if President Christine Lagarde and Co. will adjust the forward guidance at the next interest rate decision on September 9 as the central bank braces for a transitory rise in inflation.

Until then, data prints coming out of the US economy are likely to sway EUR/USD as the weaker-than-expected ADP Employment report sparks a bullish reaction in the exchange rate, with the update showing a 374K expansion in August versus forecasts for a 625K print.

Image of DailyFX Economic Calendar for US

In turn, the US Dollar may face headwinds ahead of the Non-Farm Payrolls (NFP) report as signs of a less robust recovery encourages the Federal Reserve to retain the current path for monetary policy, but a positive development may undermine the recent rebound in EUR/USD as it puts pressure on the Federal Open Market Committee (FOMC) to deploy an exit strategy sooner rather than later.

The diverging paths for monetary policy casts a bearish outlook for EUR/USD as it slipped to a fresh yearly low (1.1664) in August, but a larger recovery in the exchange rate may fuel the flip in retail sentiment like the behavior seen earlier this year.

Image of IG Client Sentiment for EUR/USD rate

The IG Client Sentiment report shows 49.17% of traders are currently net-long EUR/USD, with the ratio of traders short to long standing at 1.03 to 1.

The number of traders net-long is 0.10% lower than yesterday and 14.32% lower from last week, while the number of traders net-short is 5.91% lower than yesterday and 0.66% lower from last week. The decline in net-long interest has fueled the flip in retail sentiment as 56.70% of traders were net-long EUR/USD last week, while the marginal drop in net-short position comes as EUR/USD stages a four-day rally.

With that said, EUR/USD may stage a larger recovery in September if the NFP report dampens speculation for a looming shift in Fed policy, but the advance from the August low (1.1664) may turn out to be a correction in the broader trend as it fails to defend the range from the first-half of the year.

EUR/USD Rate Daily Chart

Image of EUR/USD rate daily chart

Source: Trading View

  • EUR/USD pushed below the 200-Day SMA (1.2001) for the first time since April as the advance from the March low (1.1704) failed to produce a test of the January high (1.2350), with the exchange rate trading to a fresh yearly low (1.1664) in August as the 50-Day SMA (1.1807) developed a negative slope.
  • However, the Relative Strength Index (RSI)diverged with price as the oscillator broke out of the downward trend from earlier this year, with the indicator holding above oversold territory even as EUR/USD failed to defend the broad range from the first-half of the year.
  • In turn, EUR/USD appears to be on track to test the August high (1.1897) as it climbs back above the 1.1780 (23.6% expansion) to 1.1810 (61.8% retracement) region, which lines up with the 50-Day SMA (1.1807).
  • Next area of interest comes in around 1.1950 (23.6% retracement) to 1.1970 (23.6% expansion), with a move above the 200-Day SMA (1.2001) opening up the Fibonacci overlap around 1.2080 (78.6% retracement) to 1.2140 (50% retracement).

— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong

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