The selloff in EURUSD continues

Marius Paun | London, UK | Senior dealer | Friday, 26th March 2021

We saw EURUSD reversing course this year and heading south as infections in Europe have risen sharply and now are threatening to trigger a third lockdown. Consequently, the most traded currency pair has dropped from a recent high of 1.2349 touched on January 6th to 1.1780 currently. After three days of the selloff, EURUSD seemed to bounce following news that EU leaders might tone down their rhetoric regarding exports bans of Covid vaccines. It made headlines as the EU looks increasingly keen to justify their failure to keep up with the UK and the US vaccination rate. They seem keen to lay blame at AstraZeneca the British co-owner for not delivering enough doses or not in time. But could the bounce in EURUSD last?

We had the European Central Bank monetary policy meeting two weeks back where the key benchmark interest rate was left unchanged as widely expected. The central bank reaffirmed the size of its PEPP at 1.85 trillion euros but said the purchase will be faster during the next quarter. It acknowledged market rates pose a risk to wider financing conditions but sees inflation picking up mostly due to ‘transitory factors’. President Christine Lagarde said that although the risks are now more balanced, the downside risks have increased for the very near term.

Very important for what happened to the EURUSD this year were the events across the Atlantic. The US 10-year Treasuries yields have rallied sharply fuelling fresh worries of rampant inflation and in turn higher interest rates. It’s the reason why the last FOMC meeting was seen as the most important since the peak of the pandemic. However, the Fed maintained its dovish tone with Chair Jerome Powell saying he’s relaxed about inflation and that it is good to see the economy recovering. Furthermore, the Fed increased its growth forecast for this year and sees unemployment declining faster than previously anticipated. No real need to raise rates for quite a while was the line yet again. So much so that analysts are now pondering whether the Fed will care more about unemployment than inflation in a quite open way.

So the US Fed thinks the economy is heading for a healthy reflation, sort of the best case scenario: pent-up demand spurring growth with long term interest rates rising slightly; inflation up, but not enough to undermine the whole recovery. A scenario that would probably require minimum intervention from the central bank. However, judging by how fast the yield’s rally is and the plunge in the stocks, investors are not that sure about that potential outcome. The million-dollar question is how much inflation can the Fed ignore before it losses credibility and is forced to take some action? If inflation does not fall back, or even worse, goes up a lot higher than anticipated, how will they convince the markets they’re not going to hike rates? The downside pressure on the EURUSD will probably be significant in that scenario as the safe haven of the US dollar would come into play.

On the other hand, there’s a potential boost from the massive infrastructure package that’s expected to be discussed sooner rather than later. It’s rumoured that a $3 trillion infrastructure plan is to be unveiled. That should bode well for the stocks but place the dollar under pressure as investors might want to go into riskier currencies. Of course, that would bring higher taxes as a distinct possibility to pay for the huge spending proposals. Janet Yellen testified before the Senate this week and she already conceded that a hike in taxes is on the cards. High taxes are notoriously tricky to balance with economic growth.

So, plenty of narratives for and against a stronger EURUSD but in the short term, the yields and the spectre of inflation could remain the decider?

The trend in EURUSD turned bearish on January 6th this year. After a sequence of lower highs and lower lows the price is now roughly matching Sept-Oct 2020 levels. The short-term moving average (red line) is below the longer-term one (blue line) and both pointing lower. Price is below both indicators and the fact that we see three consecutive drops to a new recent low is indicative of a downside momentum gathering strength.

On the upside, we can see the first line of resistance around the 1.1830 marks. It tried to break that convincingly earlier yesterday but so far it has failed. If eventually the bulls do succeed, they will set their eyes on 1.1880 which also acted as good resistance in Oct-Nov 2020. On the downside, sellers need to breach support around 1.1760 first followed by 1.17. If they manage to breach those targets it could gather enough bearish momentum for a challenge at 1.16, the low since July last year.