However, the recovery stalled at the 1.2545 area, where the 20-hour SMA offered resistance, confining the cross to a stage of sideways consolidation between those levels. At time of writing, EUR/USD is trading around 1.2515, down 0.1% on the day.
Volume is expected to remain low and ranges to persist through rest of the session as investors seem unwilling to take new positions ahead of the US Memorial Day weekend.
This week, EUR/USD dropped below the January lows at 1.2624. This was a high profile support level and the break below suggests that EUR/USD trading has entered a new phase. The euro is paying an ever bigger price for the inability of Europe to solve its economic- and financial crisis.
Since the end of 2009, (start of the Greek crisis), the flaws of the euro construction have become an important driver of the debt crisis. Investors questioned the adequacy of the EMU institutional framework to handle the impact of the global debt crisis on the EMU area. EUR/USD set a crisis low at 1.1877 in June 2010, after the first Greek rescue package. Doubts on the EMU construction were not constantly present throughout the whole period and other issues played a role, too. Late 2010, EUR/USD profited from overall dollar weakness as the Fed announced more monetary easing in the US (QE2). In the first half of 2011, the euro profited when the ECB started its policy normalisation and raised rates twice. In a broader perspective, the euro held up well during the (European) debt crisis. This was partially due to underlying weakness of other major currencies (USD) but also because investors were confident that the ECB wouldn’t use inflation as a tool to solve the EMU debt crisis (in the end, deflation is supportive for the currency). At the same time, markets held to the basic view that, in the end, the EMU construction would survive the debt crisis.
Since mid 2011, the EMU debt crisis entered a new phase. The July EMU Summit failed to convince markets that the EMU had a credible strategy to keep the debt of the peripheral EMU countries on a sustainable path. The ECB had to backtrack on its normalisation call. The policy rate hikes were reversed and the bank took several unconventional measures to mitigate financial stress on the intra-EMU sovereign bond markets and to guarantee liquidity in the banking sector. So, the ECB lost its aureole as prime anti-inflation fighter and came close to printing money as did other central bankers. The euro lost its comparative ‘advantage of orthodoxy’ and EUR/USD reached a correction low at 1.2624 in January. The ECB’s 3-year LTRO’s removed temporary market fears that peripheral European sovereigns would lose market access. Global sentiment on risk improved and the euro entered temporary calmer waters.
At the end of April, the period of relative calm ended. The LTRO brought some relief, but not enough to avoid countries like Greece, Spain or Italy to be captured in a negative spiral as increased austerity efforts reduce growth further. Questions about the debt sustainability in these countries only increased as low/negative growth raises the weighted of debt on the economy. In addition, the election results in Greece and France indicated that the political backing for austerity and fiscal consolidation is faltering. A Greek exit has become a real possibility. So, the euro has not only lost the support of ECB orthodoxy. Even worse, the euro construction itself has become a major source of uncertainty. If EMU policymakers do not rapidly come up with a credible plan to stop contagion, ever more investors inside, and even more outside, the euro zone will reduce exposure on the single currency. The outcome of this week’s informal EMU summit at least didn’t show that there is a sense of urgency amongst EU policymakers to take a ‘big step’ forward to a fiscal- and political union anytime soon. The market is already very short euro (e.g. according the CFTF CME euro short open interest is at historical highs) and the EUR/USD cross rate is oversold on the technical charts, but this shouldn’t prevent investors from using any upticks to further offload EUR/USD long exposure. At this stage it is difficult to see how political and institutional uncertainty will be reduced in a profound way ahead of the new Greek elections (June 17).
Aside from the fundamental issues, the cyclical developments are also conspiring against the euro. The EMU avoided a recession in Q1 as German growth was unexpectedly strong. However, recent survey evidence indicates that the economic situation in Europe is deteriorating at an accelerating pace, not only in the periphery, but even in core countries like Germany. In this context, more monetary easing from the ECB, including a rate cut at the July or even at the June meeting, is highly likely. The likes of the BoE and the Fed might also take additional steps to support the economy if the outlook on global economic growth would deteriorate further. However, in any scenario, the ECB will be seen as having the biggest job to do and as the last one to start policy normalisation, whenever that will be.
To summerize. The political uncertainty, an institutional framework with obvious deficiencies and a negative cyclical- and monetary context all point to further weakness for single currency. In such a context, we expect EUR/USD to decline further after the break below the 1.2624 key support.
Technicals
Looking at the technical charts, EUR/USD dropped below the 1.3548/1.2978 consolidation range early May. This opened the way for a return to 1.2624 (Jan 2012 low). This level was broken earlier this week, signalling the risk for stop-loss EUR/USD selling. The pair is oversold, but if the institutional stalemate persists, any upticks will be used to further offload EUR/USD long exposure. The event risk of the Greek elections in a context of declining market liquidity might exacerbate the downtrend.
On the charts, 1.1877 marks the lows of the EUR/USD cross rate since the start of the credit crisis in 2007. In case the decline of the euro would become less orderly than has been the case of late, this level might come in the picture sooner than expected.
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