Central Bank Stance Suggests Top in EUR/USD

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By: Richard Cox

When we look at the forex markets as a whole, some interesting trends have developed in the first half of this year. Most of the activity as focused on the US Dollar, which is not entirely surprising given the fact that the greenback tends to define many of the larger trends that are present in the market. But what might come as a surprise is the fact that the Dollar has met widespread selling pressure, even against currencies that are tied to currencies with much lower annual growth rates. Perhaps the best example of this can be seen in the Eurozone, where annualized GDP growth is barely in positive territory and the regional unemployment rate is still hovering around 11.3%.

Comparative Growth Rates

These are highly troublesome figures, so the year’s rally into the 1.40 level might seem to be out of line with the underlying fundamentals. In contrast, the US unemployment rate is a full 5% lower and has fallen to lows that have not been seen in more than 5 years. For those basing forex trades on the fundamental data, this creates a difficult scenario to establish positions. But when we look at both the failure in EUR/USD at 1.40 and the changing stance at the European Central Bank (ECB), there is strong reason to believe that the yearly trends have run their course and that market prices are about ready to head back toward its longer term averages.

“In the early parts of this year, the Euro was making moves that frustrated many traders implementing comparative growth strategies,” said Jane Wyman, markets analyst at Orbex. “But the market fell-off nearly 250 points after hitting the 1.40 level and the EUR/USD is starting to look as though it is posting a legitimate downside reversal.” Ultimately, what this means is that forex traders should be viewing upside moves in the EUR/USD as a new opportunity to start establishing long positions. As long as we are able to hold below the 1.40 level, it is likely that markets will close the year lower than they are trading currently.

ECB Stance

Additional support for this line of reasoning comes from the fact that the ECB has publicly stated concern over the level of the Euro itself. The ECB President has made it clear that the central bank believes a rallying Euro will weigh on the prospects for export companies in the region. This is essentially an added drag on the economy that the ECB cannot afford, and the central bank will now be forced to enact new stimulus measures (and even lower the base cash rate) in order to protect the economy from further shocks. Here, it is important to remember that we are really not that far away from the sovereign debt crisis that gripped the market for several years, so the ECB will need to do what it can to prevent the market from falling into the whole again.

Richard Cox is a university teacher in international trade and finance, and his lessons include macroeconomics and price behavior in equity markets. He also writes for various financial publications across the web, and his investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities).