The EUR/USD has had quite a run over the last few weeks, trading from a low of 1.0800 on May 18th to a high of 1.1385 on Friday. Will this run continue or is it time for a correction?
Last week, stimulus continued in Europe as the ECB increased PEPP by 600 billion Euros and said they would extend the program through 2021 and would reinvest the maturing principal until the end of 2022. In addition, Germany agreed they would add in another 130 billion Euros to their stimulus funding. Also, 2 weeks ago, the EU proposed additional and revised language to the France/Germany proposal, which included 500 billion Euros in grants and 240 billion Euros in loans. With huge supply of funds, logic would suggest that the Euro should be lower.
The economic data has not been kind to the Euro either. Just looking at Germany alone, one may expect the Euro to be lower. Germany reported a 26% drop in April factory orders on Friday (EUR/USD did actually trade lower that day.) And as recently as today, industrial output was worse than expected, coming in at -17.9% vs -16.8% expected. In addition, UK/EU Brexit talks have stalled, which is also not supportive for the Euro.
However, there is one caveat that has been overlooked so far here, and it is that of the tremendous weakness of the US Dollar! As we discussed in the chart of the week in the week ahead report, the US Dollar Index and the S&P 500 have a -.94 correlation coefficient, meaning that the DXY and the S&P 500 trade inversely with each other 94% of the time! As the Euro makes up a majority of the DXY index, it makes sense that the Euro would also trade in the opposite direction of the DXY. Therefore, stocks and EUR/USD have a high positive correlation and trade together a majority of the time. So, as the S&P 500 goes, so does EUR/USD.
In addition, the Fed meets on Wednesday. As with all central bank meetings lately, the key to determining if the EUR/USD continues its move higher will be to see if the Fed is still in extreme dovish mode. Remember, the ECB is already in negative rate territory while the Fed has rates at 0%. So, who has more room to lower rates if needed? The Fed. And if the Fed goes negative, the US Dollar will weaken, and EUR/USD bid will continue.
Technically, we can see on the daily EUR/USD chart below that the correlation coefficient between the EUR/USD and the S&P 500 is indeed high, at +.96. Price traded out of the symmetrical triangle and moved aggressively towards the 161.8% Fibonacci extension from the highs on March 30th to the lows of April 24th, near 1.1400. The RSI turned lower on Friday, however, still remains in overbought territory. There may be some profit taking or unwind from the trade ahead of the FOMC meeting on Wednesday.
Source: Tradingiew, Forex.com
On a 4-hour timeframe, EUR/USD has been in a strong upward channel since May 25th. Last week, the pair had a false breakout above the top of the channel and traded back into it. First support is at the bottom of the channel near 1.1300. If price breaks below the channel, the next support is horizontal support near 1.1150, where buyers may be aggressive to buy the dip. If price moves higher, initial resistance is Friday’s highs near 1.1400 and then the highs from early March near 1.1495.
Source: Tradingiew, Forex.com
The next move in EUR/USD will depend on one of two things: 1) Stocks: with such a high correlation at the moment, if stocks turn lower, EUR/USD is likely to follow 2) The Fed Interest Rate Decision on Wednesday: depending on the degree of dovishness, it could affect the US Dollar, which is turn will affect the Euro. In addition, watch for potential profit taking ahead of the FOMC meeting on Wednesday!