EURUSD: Pressured by monetary policy divergence

By Lukman Otunuga, Research Analyst at FXTM

The past few trading months have certainly not been kind to the Euro as political risk in Europe, soft domestic economic data and external factors weighed on the currency.

Euro weakness became a dominant market theme during the second trading quarter after political uncertainty in Italy and Spain reignited fears of instability in the Eurozone. Although European political risks eventually subsided, losses remained intense thanks to a broadly stronger Dollar across the FX markets. Any surviving optimism over a possible Euro rebound was squashed thanks to the European Central Bank’s dovish guidance on interest rates. While the ECB announced that it will end its QE program by year-end, its hesitance to remove the zero-interest rate policy (ZIRP) until after Summer 2019 simply widened the monetary policy divergence with the Federal Reserve.

On the other side of the Atlantic, the Dollar reigned supreme amid the bullish sentiment towards the US economy. The improving economic landscape in the United States coupled with rising inflationary pressures has boosted market expectations over the Fed raising interest rates at least two more times this year. With the widening interest rate differentials clearly in favour of the Dollar, further upside in the USD can’t be ruled out over the medium to longer term.

As we head into the third quarter of the trading year, the monetary policy divergence between the European Central Bank and Federal Reserve is likely to encourage the EURUSD to respect its current negative trajectory. However, global trade developments revolving around the US, China and EU remain a wildcard that has the potential to impact the markets at any given second. If the Dollar continues to strengthen over concerns of an impending trade war, this could negatively influence the EURUSD significantly this quarter.

It is worth noting that a trade war has the ability to spark global instability, consequently obstructing monetary policy normalization by major central banks. Trade war concerns could for example be used as a reason for the ECB to remain hesitant towards offering guidance on the potential timing of EU interest rate rises. A trade war is seen as a serious threat to Eurozone growth.

Gelogis

Regarding the technical picture, the EURUSD remains under noticeable selling pressure on the monthly charts with bears grinding away at the 1.1550 support level. A solid monthly close below this psychological level suggests that the EURUSD’s monthly trajectory will turn further negative, with the downside risks possibly sending prices towards 1.1336 and 1.1015, respectively.

Technical traders will closely monitor if weekly bears are brave enough to challenge the 1.14635 50% and 1.1926 61.8% Fibonacci retracement levels. A scenario where 1.1550 proves heavily supportive on the weekly charts could result in a technical rebound back towards 1.2000.

 

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