FOREX 5 minutes to read

Conditions improving for EURUSD rally

John Hardy

Head of FX Strategy

Summary:  GBP is in range following Wednesday's Tory confidence vote while EUR looks willing to rebound versus USD, particularly if next week's Fed session gives a dovish enough hike.


While sterling volatility remains high and dominates the focus, there is no further visibility from UK prime minister Theresa May surviving the No Confidence vote yesterday. If this vote was meant to give her a stronger mandate, it has somewhat failed, with more than a third of her own party wanting her to step down in the 200-117 result.

Sterling positions could remain expensive to hold in both options time decay terms and on the risk of spiky movements on the next headlines. It is doubtful that May can wring any notable concessions from EU leaders as all of the action in the Brexit denouement is likely to remain on the home front from here.

US-China developments have driven a modest revival in risk appetite and weaker US dollar, as China is apparently moving on car tariffs, has put in bids for huge shipments of US soybeans, and is even said to be easing off its Made in China 2025 programme. On the other hand, the case of the Huawei CFO arrest and requested extradition weighs, as does the risk that the US is set to go full throttle on accusing China of cyber- and economic espionage

The noise on Brexit and US-China trade talks has drowned out key developments in Europe, including a strong dip in Italy’s two-year BTP yield as budget negotiations with the EU are taking on a conciliatory tone. The EU summit today and tomorrow may put the issue behind us for now. The latest offer from Italy’s finance minister Tria is 2.05% of GDP, and the recent Yellow Vests protest in France is a game-changer as fiscal expansion announced by Macron will take France’s budget next year beyond the EU’s 3.0% growth and stability pact threshold.

As well, the new German CDU leader is a far more pro-European figure than the alternative and the pattern of populist revolt across Europe may finally be spreading to the EU’s capitals, even if the threat from the populists has not sufficiently penetrated the thick skulls on the EU commission. We are increasingly open-minded on positive euro developments, if not fully on board.

Building a EURUSD rally scenario

Probabilities still seem somewhat balanced, but in light of the last couple of days of developments, we are increasingly open to the idea that a combination of the following circumstances could lead to reasonable rally in EURUSD toward 1.2000, or at least into the 1.1700-1.1800 range in the coming weeks to couple of months, with the first four being the most important:

• Stable or lower Italian BTP yields (the large drop is an already underappreciated factor).
• Deepening sense of a US-China trade ceasefire/stable USDCNY, even if the longer-term relationship remains rocky.
• A dovish hike from the Fed or (much more forcefully) no hike at all at next week’s FOMC meeting.
• A strong risk response to the Fed’s ongoing shift to a more neutral outlook.
• US government shutdown over Trump’s insistence on border wall funding.
• Brexit process pointing to a delay or an eventual second referendum.

Chart: EURUSD

Something has to give here as we’ve traded in a very tight range for over a month and spent the overwhelming majority of the last seven months in the 1.1300-1.1800 range. An upside break likely requires a combination of the factors listed above, while a downside break might require the opposite: an ugly turn in US-China negotiations, higher EU existential risks and an ugly deterioration in risk appetite.
Enlarge
Source: Saxo Bank
The G10 rundown

USD – tentative signs of a sell-off and we’re definitely not there yet, but a more notable breakthrough with China and a look at the action post-FOMC next week likely to spark a flurry of activity ahead of year-end.

EUR – changing our tune a bit on the euro for the short term if Italy’s budget situation is squared away at the EU summit here and risk appetite avoids any mishaps linked to US-China. The ECB today looks a non-event, with political developments in the driver’s seat across Europe now.

JPY – improved global sentiment not the stuff of a yen rally and yen likely to follow USD in directional terms in the crosses here. 

GBP – sterling showing signs of resilience, but we steer clear given the lack of visibility – a notable technical development if GBPUSD can’t hold below 1.2700. EU Summit today and tomorrow could throw off further Brexit headlines.

CHF – CHF weaker as sterling weakness eases and as Italian yields plummet – more to come if euro sentiment improves, though we likely need a final answer on what Brexit looks like to get a more extended CHF sell-off.

AUD – held back by credit crunch concerns in the domestic economy, while further signs of progress in US-China negotiations could provide a countervailing force.

CAD – USDCAD not able to get comfortable here above 1.3400 and despite the dovish tilt from the Bank of Canada at its last meeting, a similar dovish tilt from the Fed next week and generally enthusiastic response from the market could mean that USDCAD remains capped here. 

NZD – AUDNZD putting in a solid bounce after a hyper-extended NZD rally. Don’t know if we’ve posted a local low there, but next several months looks like more upside than downside potential.

SEK – big SEK move potential on next week’s Riksbank. Yesterday saw an attempt above 10.35 area resistance failing – an improved outlook for the euro likely sees EURSEK lower.

NOK – don’t see any reason with this backdrop to see EURNOK to break above 9.75. Norges Bank expectations nil and recent stability in oil helps NOK at the margin.

Upcoming Economic Calendar Highlights (all times GMT)

• 0900 – Norway Deposit Rate
• 0930 – Norway Norges Bank Olsen presser
• 1000 – IEA Oil Market Report
• 1100 – Turkey Central Bank Rate 
• 1245 – ECB Meeting
• 1330 – ECB President Draghi presser

You can access both of our platforms from a single Saxo account.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)