EUR: Modest reversal lower is likely - HSBC

Analysts at HSBC believe that a modest reversal lower is likely for EUR and are looking for EUR-USD to pull back below support at 1.1600 and perhaps gravitate towards the 50-day MA of 1.1491. 

Key Quotes

“There may be some intermittent support at 1.1542, the 23.6% Fibonacci retracement of the January to August rally. Our tactical caution on the EUR means we have chosen to take profit on our long EUR-GBP trade at 0.9110 for a total return of 2.50%.”

“Our medium-term bullishness on the EUR is unchanged. This is a currency destined to challenge 1.20 against the USD, in our view, on the back of the ECB’s shift towards the exit from ultra-accommodative monetary policy. However, it is also a currency that has run a long way rather quickly and has shown signs of exhaustion and a loss of momentum so far in August. For example, on August 15 EUR-USD failed to enjoy any lasting support from strong German GDP data or news that the ECJ will need to examine the legality of the ECB’s QE programme. At a less stretched level, one might have expected the EUR to capitalise.”

“The elevated level of the EUR also creates asymmetric risks around ECB rhetoric, notably that of President Draghi. He is due to speak in Germany on 23 August and then will attend the Jackson Hole economic symposium, which runs from 24-26 August. Reuters, citing ECB sources, suggests he is unlikely to announce any policy change. For us, this means the risks are to the downside for EUR in terms of his observations or comments. EUR-USD has appreciated 1.7% since the ECB’s 20 July meeting, not a massive rally but still enough to potentially prompt a response. The latest ECB meeting minutes expressed concerns that the EUR could overshoot in the future, the first sign of growing unease perhaps.”

“The 1.7% move since that ECB meeting built on the rally seen since January and means that EUR-USD is up a more sizeable 11% since the start of the year. The trade-weighted EUR is up 6.3%. Core inflation edged higher to 1.2% YoY in July but our economics team suspect part of the reason for this uptick was due to the lagged effects of earlier EUR weakness. The scale of the rally in EUR so far in 2017 may make the ECB more mindful of the headwinds to future inflation from the lagged effects of EUR strength. This is especially so as other measures of price pressure remain subdued. Wages growth is benign despite an unemployment rate of 9.1%, close to what used to be considered the natural rate. Hiring is strong but wages are not, which suggests the natural rate may be even lower.”

“The second factor is that the ECB may be surprised that the EUR extended its gains to such an extent after the last ECB meeting given President Draghi was not especially hawkish. There was no change to the forward guidance, no shift in the asymmetry around future QE changes, and no discussion of what to do with QE beyond December. The temptation may be to sound rather more vocal about the EUR than President Draghi did at the last press conference when he said “the re-pricing of the exchange rate has received some attention during the various exchanges of views, and in various ways.”