Will Euro Hit New Highs?

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
It has been an exceedingly quiet day in the foreign-exchange market with currencies trapped in tight 40- and 50-pip ranges. The high for USD/JPY was 110.92 and the low was 110.60. EUR/USD had a slightly wider range of 48 pips while GBP/USD fluctuated within a 45-pip range. Forex traders may have to get used to these quiet trading days because it is August, when many Europeans are on vacation and there’s very little market-moving data on the calendar this week. The New Zealand dollar is the only currency seeing any meaningful volatility and that could remain the case as the Reserve Bank of New Zealand’s monetary policy announcement is the most important event risk on this week’s calendar.

The U.S. dollar held onto its gains versus the Japanese yen and extended its rise against all of the major currencies with the exception of the euro. However the gains were modest with USD/JPY unable to rise above 111 as Treasury yields fall and investors eye growing tensions in Asia. Over the weekend the UN Security Council with the support of China and Russia tightened sanctions on North Korea. In return, NK threatened retaliation with the official Korean Central News Agency saying “there is no bigger mistake than the United States believing that its land is safe across the ocean.” If tensions between North Korea and the U.S. turn into military action, stocks will crash from their record-breaking levels, taking USD/JPY down with them. But if that doesn’t happen, USD/JPY will most likely drift higher and find its way above 111.00. Comments from Fed Presidents Bullard and Kashkari had no major impact on the greenback. Bullard, who is not a voting member of the FOMC this year, said he’s ready to start balance-sheet reduction in September but rates should be left where they are. Kashkari, a voting member of the FOMC and a vocal dove does not believe balance-sheet shrinkage will disrupt the markets as the economy is doing pretty well.

While the dollar is up against many currencies, it is down versus the euro, leading our clients to ask if EUR/USD will hit new highs. We’re addressing this question here as it is certainly on the minds of many of our readers. There’s no doubt that the euro is resilient. Despite an unexpected decline in German industrial production and fall in the Sentix investor confidence survey, the single currency still managed to outperform the greenback but we don’t think those gains will last. We expect EUR/USD to make a trip down to 1.16 before there’s any chance of a move to 1.20. We are just beginning to see the negative implications of a rising currency and unfortunately more disappointments are likely. If Tuesday’s German trade balance also misses expectations, it could kick start a deeper correction in the currency. With all of this in mind, the EUR/USD could STILL see new highs beyond 1.19 if U.S. data fails to impress because the main reason the euro is so strong is skepticism about Fed policy, which post NFP, hasn’t changed much.

After closing below the 20-day SMA for the first time since June 26, GBP/USD spent the whole day below this moving average and as long as it remains under 1.3060, the path of least resistance will be lower. Sterling is the most vulnerable to a deep correction this week as there was nothing positive in the most recent Bank of England Quarterly Inflation report and monetary policy announcement. Given how much GBP/USD rose in the last 4 months (from 1.24 to 1.3250), the tone of the central bank and the healthy U.S. nonfarm payrolls report means 1.3270 is most likely the top in GBP/USD. On a technical basis, this is also where the 20-day SMA on the monthly chart and the 23.6% Fib retracement of the 2014 to 2016 sell-off converge, making it the perfect stopping point for the pair after a prolonged rally that took it from 1.20 in October of last year to 1.3270 this month. Next stop for GBP/USD should be 1.3000 and then 1.2920.

All 3 of the commodity currencies traded lower Monday, which should not be a surprise to our readers as we’ve been looking for corrections this week. The New Zealand dollar was hit the hardest as traders took profits on long positions ahead of the RBNZ’s rate decision. The RBNZ is widely expected to leave rates unchanged but the recent trend of softer data suggests that the central bank could be less hawkish. Sunday night’s lower 2-year inflation expectation index gave NZD/USD traders even more reason to cut their longs. Like GBP/USD, NZD/USD has fallen below the 20-day SMA and is now poised for a deeper correction down to the 50-day SMA near 73 cents. Meanwhile, it has been 5 trading days since we’ve seen a rally in AUD/USD and even Sunday night’s stronger construction PMI index failed to lift the pair. Still, there appears to be significant support at 79 cents so until that breaks, there could be more consolidation. China's trade balance should decide whether that level holds or breaks in the near term. As for USD/CAD, it extended its recovery above 1.2700 but settled below the round number. No economic data was released but oil prices retreated.