EUR/USD forecast: Downside risks persist despite recovery

Amid a lack of any major news, the FX markets have been largely in consolidation mode in the first half of Tuesday’s session. The US dollar eased along with bond yields and oil prices, allowing downbeat currencies like the euro to rebound modestly. With US CPI data due for release on Wednesday, don’t expect much in the way of a sharper decline in USD ahead of it. If anything, we could see the dollar buying resume, especially if crude oil prices catch a bid again amid the ongoing situation. We maintain a modestly bearish EUR/USD forecast and think 1.10 handle could be reached, potentially as early as the next few days.

 

Dollar consolidates gains

 

The dollar started the week on a firmer footing, although some of that strength has faded alongside the pullback in oil prices. Even so, the increase in military activity in the Middle East should keep crude prices well supported, which in turn should provide a floor under the dollar.

 

Today’s US calendar is light, with attention likely to be on tomorrow’s CPI report. Ahead of it, market remains net long USD against most major currencies, in some cases extremely long. So, the dollar positioning is beginning to look a little stretched. But that does not necessarily mean a reversal is imminent. We would need a clear macro catalyst to trigger one, and for now that is difficult to identify. Expectations for Fed tightening remain firmer than those for most other major central banks, limiting the dollar’s downside potential.

 

It is also worth keeping an eye on the global bond markets. We have seen yields come down a notch or two in recent days. But that is coming on the back of a massive rise in yields, or sell-off in bond prices. If the weakness in bonds remain in place, this should also provide additional support for the dollar, all else being equal.

 

Will US inflation data surprise?

 

Consensus is looking for core CPI to rise 0.2% month-on-month tomorrow, putting the annual rate at 2.5%, up from 2.4%. Headline CPI is expected to accelerate to 0.6% m/m and 3.6% y/y, from 3.4% in August. With expectations already relatively well defined, a modest upside surprise may be needed to generate a meaningful dollar rally, while if the data is as expected this should provide only modest weakness in US dollar. The scope for a large negative reaction looks likely to be limited.

 

EUR/USD forecast undermined by French concerns

 

Meanwhile on the euro side of things, beyond several ECB appearances, including Christine Lagarde’s, the single currency faces a relatively thin domestic calendar this week. Markets are already fully pricing a December rate hike, leaving limited room for further hawkish repricing, while an October move still looks unlikely – especially when you consider the French situation. There is clearly scope for further deterioration if French government bonds continue to weaken, making it a largely unfavourable backdrop for the EUR/USD forecast.

 

EUR/USD technical analysis and key levels to watch

 

Despite today’s bounce, the risks to our near-term EUR/USD forecast remains tilted to the downside. The pair has been under heavy pressure, as reflected by the fact it posted a fifth consecutive weekly loss last week. Longer-term momentum is clearly bearish, meaning today’s rebound should be seen as a counter trend move first and foremost, until proven otherwise.

 

 

The 1.1215/20 area, which marks the 127.2% Fibonacci extension of the upswing that began in June, has now turned into resistance on the EUR/USD. This is an important level to watch in the days ahead. A move back above it would turn that level back into support and could signal some stabilisation. Above that, there isn't much in the way of obvious resistance until the 1.1325/55 area.

 

If that doesn't happen and the weakness continues (which is my base case), the immediate downside target is the liquidity sitting below recent lows, around 1.1150.

 

A break there would bring the 1.1100 handle into focus, closely followed by 1.1085, the 161.8% Fibonacci extension of the same June upswing. Below those levels, 1.1000 would become the next major downside target.