Euro Forecast Overview:
- The Euro’s strong start to October has continued to build on the back of progress on the Brexit and US-China trade war fronts. With a Brexit deal seemingly secured, EUR/GBP has been the only EUR-cross trading lower month-to-date, off by -2.45%.
- Overnight index swaps are currently pricing in a 77% chance of no change in rates at the October ECB meeting. Overall, there is a 63% chance of no change in rates by the end of the year.
- Per the IG Client Sentiment Index, EUR/JPY and EUR/USD gains may continue to build.
See our long-term forecasts for the Euro and other major currencies with the DailyFX Trading Guides.
Euro Rally in October Continues to Build
The Euro’s strong start to October has continued to build on the back of progress on the Brexit and US-China trade war fronts. With a Brexit deal seemingly secured, EUR/GBP has been the only EUR-cross trading lower month-to-date, off by -2.45% at the time of writing. Otherwise, gains continue to build versus the trio of safe haven currencies: EUR/JPY is now the top performer in October and Q4’19 thus far, adding 2.45%; EUR/USD is up by 2.05%; and EUR/CHF has gained 1.02%.
News Flow Has Been Kind to the Euro
There’s no denying that the news wire has been a source of optimism for the Euro thus far in October. Last week, the news that Eurogroup finance ministersstarted a “rainy day fund” began to turn the tides. The news that a fiscal stabilization fund has been established to be used in the event of future crisesis a step in a direction of making the Eurozone more sustainable over time.
Now, progress on the Brexit front – a deal appears to be in place, needing approval from UK parliament among others – suggests that European Union leadership may have avoided the worst case, no-deal, hard Brexit scenario.
If Brexit is seen as a litmus test for the viability of the European Union (and thus, the Euro) in the long-term, securing a deal that allows the UK to leave while protecting the common market’s core interests may only be viewed as a positive development for the Euro. The good news is coming at a time when European leadership is about to see a sea change: Christine Lagarde is coming in as President of the European Central Bank at the end of this month.
Eurozone Inflation Expectations Following Brent Oil
Next week’s ECB meeting will be the last under Mario Draghi’s tenure. Outgoing ECB President Draghi’s preferred measure of inflation, the Eurozone 5y5y inflation swap forwards, currently are trading at 1.221%, comfortably above the yearly low set last week on October 3 at 1.115%. Eurozone inflation expectations continue to trend lower overall, however: Eurozone 5y5y inflation swap forwards read 1.274% one month ago on September 19.
Eurozone Inflation Expectations versus Brent Oil Prices: Daily Timeframe (October 2018 to October 2019) (Chart 1)
The relationship between Eurozone 5y5y inflation swap forwards and Brent oil prices has tightened up over the past few weeks. The current 20-day correlation between Eurozone inflation expectations and Brent oil prices has strengthened to 0.70 from 0.56 one month ago on September 19.
Given the state of Eurozone 5y5y inflation swap forwards – a medium-term market-derived measure of inflation expectations – it shouldn’t be a surprise that the headline Eurozone inflation reading released yesterday came in soft, at 0.8% versus 0.9% expected (y/y), and the core remained weak as well, at 1% unchanged (y/y).
Eurozone Economic Data Still Disappointing, However
The forex economic calendar is light for the Euro for the remainder of the week after the disappointing October German ZEW survey on Tuesday and the weak final September Eurozone inflation report on Wednesday. Overall, Eurozone economic data has continued to disappoint over the past few months, at least when trying to measure releases relative to expectations. The Citi Economic Surprise Index for the Eurozone, a gauge of economic data momentum, is down to -68.8 today from -27 one-month ago on September 19 and -8.8 on July 18.
ECB Rate Cut Timeline Being Pushed Back
Alongside progress on both the Brexit and the US-China trade war fronts, G10 currencies’ central banks interest rate cut odds have dropped in recent days. To no surprise, the European Central Bank has seen rate cut odds ease further.
According to overnight index swaps, market participants are currently discounting a 77% chance of no policy change at the October ECB meeting, down from 80% two days ago. But this is due to rising odds of a 10-bps rate hike, from 20% to 23%. Nevertheless, having just previously cut interest rates last month, it seems highly unlikely that the ECB would reverse course in such quick order.
European Central Bank Interest Rate Expectations (October 17, 2019) (Table 1)
It still holds that ECB rate cut expectations are holding on the path towards dissipating entirely: two months ago, there was a 70% chance of a 10-bps rate cut and a 29% chance of a hold. Rates markets barelyanticipate more action from the ECB in the first half of 2020, with rates markets now pricing in the next rate cut coming in June 2020. Two days ago, there was a 68% chance of a 10-bps rate cut in April 2020; now, odds of a cut in April have fallen to 48%.
EUR/USD RATE TECHNICAL ANALYSIS: DAILY CHART (OCTOBER 2018 to OCTOBER 2019 INTRADAY) (CHART 2)
Between the end of August and the end of September, a range formed for EUR/USD between 1.0926 and 1.1110. A brief dip outside of the range occurred at the end of September and start of October, but channel support was found dating back to the August and November 2018 lows (as well as the descending trendline from the January and April 2019 swing highs).
Now, EUR/USD has cleared the descending trendline from the June, July, and September highs, and support has been established at the daily 8-EMA, suggesting that a turn in price action has occurred. EUR/USD rates are above the daily 8-, 13-, and 21-EMA envelope, while Slow Stochastics have reached overbought territory. Meanwhile, daily MACD continues to climb back towards its signal line.
The technical picture is offering more evidence that a false bearish breakout has occurred below 1.0926. False breakouts typically yield reversals back to the other side of the consolidation. As previously noted, in this case, “EUR/USD would be looking for a return towards the prior range high near 1.1110. A move above this level would suggest that a meaningful bottom has been found in EUR/USD rates.”
IG Client Sentiment Index: EUR/USD Rate Forecast (October 17, 2019) (Chart 3)
EUR/USD: Retail trader data shows 43.5% of traders are net-long with the ratio of traders short to long at 1.3 to 1. The percentage of traders net-long is now its lowest since Jun 14 when EUR/USD traded near 1.12103. The number of traders net-long is 20.2% lower than yesterday and 18.3% lower from last week, while the number of traders net-short is 9.0% higher than yesterday and 10.4% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EUR/USD-bullish contrarian trading bias.
EUR/JPY RATE TECHNICAL ANALYSIS: DAILY CHART (OCTOBER 2018 to OCTOBER 2019 INTRADAY) (CHART 4)
Sharp reversals in recent days has altered the EUR/JPY technical picture in a material way. The short-term symmetrical triangle in place going back to the mid-July swing high did not yield a continuation effort to the downside. Instead, now that EUR/JPY rates are comfortably above the daily 8-, 13-, and 21-EMA envelope ( which is in bullish sequential order) while daily MACD rises through its signal line and Slow Stochastics holds in overbought territory, the near-term path of least resistance is higher. A close above the September high at 120.07 opens up airspace for a return back towards the descending trendline from the September 2018 and April 2019 highs near 121.00 over the coming sessions.
IG Client Sentiment Index: EUR/JPY Rate Forecast (October 17, 2019) (Chart 5)
EUR/JPY: Retail trader data shows 50.0% of traders are net-long with the ratio of traders long to short at 1.0 to 1. The number of traders net-long is 14.2% lower than yesterday and 15.4% lower from last week, while the number of traders net-short is 11.6% lower than yesterday and 0.9% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests EUR/JPY prices may continue to fall. Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current EUR/JPY price trend may soon reverse higher despite the fact traders remain net-long.
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— Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher, email him at email@example.com