EUR/USD Rate Vulnerable to Diverging Policies Between ECB and FOMC

EUR/USD Rate Talking Points

EUR/USD appears to be stuck in a narrow range with both the Federal Reserve and European Central Bank (ECB) rate decision on tap for later this week, but the Governing Council’s wait-and-see approach for monetary policy may drag on the Euro as President Christine Lagarde and Co. remain in no rush to implement higher interest rates.

EUR/USD Rate Vulnerable to Diverging Policies Between ECB and FOMC

EUR/USD tracks sideways after defending the November low (1.1186) during the previous week, and it remains to be seen if the fresh projections coming out of the Fed will sway the broader outlook for the exchange rate as the central bank carries out its exit strategy.

As a result, the update to the Summary of Economic Projections (SEP) may show a steeper path for the Fed fund rate as Chairman Jerome Powell and Co. “generally judged that the Committee’s criterion of substantial further progress had clearly been more than met with respect to inflation,” and the US Dollar may continue to outperform its European counterpart in 2022 if the FOMC shows a greater willingness to deliver a rate hike sooner rather than later.

Meanwhile, the ECB may merely attempt to buy time at its last meeting for the year amid the renewed restrictions in response to the Omicron variant, and the Governing Council may continue to brace for a transitory rise in price growth as officials “foresee inflation rising further in the near term, but then declining in the course of next year.”

In turn, the ECB may continue to support the Euro Area in 2022 as President Lagarde and Co. “foresee inflation in the medium term remaining below our two per cent target,” the Euro may face a more bearish fate over the coming months as long as the Governing Council stays on track to carry out “a moderately lower pace of net asset purchases under the pandemic emergency purchase programme (PEPP) than in the second and third quarters of this year.”

The deviating paths between the ECB and FOMC may keep EUR/USD within a bearish trend as it trades to fresh yearly lows in the second half of 2021, but the tilt in retail sentiment looks poised to persist even as the exchange rate tracks sideways after defending the November low (1.1186).

The IG Client Sentiment report shows 64.05% of traders are currently net-long EUR/USD, with the ratio of traders long to short standing at 1.78 to 1.

The number of traders net-long is 5.49% higher than yesterday and 1.08% lower from last week, while the number of traders net-short is 7.76% higher than yesterday and 0.56% higher from last week. The decline in net-long interest has done little to alleviate the crowding behavior as 64.07% of traders were net-long EUR/USD last week, while the rise in net-short position comes as the exchange rate appears to be stuck in a narrow range.

With that said, EUR/USD may continue to consolidate within the monthly range amid the central bank rate decisions on tap for later this week, but the diverging paths between the ECB and FOMC may keep the exchange rate within a bearish trend as it trades to fresh yearly lows in the second half of 2021.

EUR/USD Rate Daily Chart

Source: Trading View

• Keep in mind, EUR/USD has traded to fresh yearly lows in the second half of 2021 as the advance from the March low (1.1704) failed to produce a test of the January high (1.2350), and the bearish trend looks poised to persist as both the 50-Day SMA (1.1460) and 200-Day SMA (1.1795) reflect a negative slope.
• Nevertheless, a rebound emerged following the failed attempt to test the July 2020 low (1.1185), with EUR/USD trading within a defined range after defending the November low (1.1186) during the first full week of December.
• Need a break above the monthly high (1.1360) to bring the 1.1440 (78.6% expansion) to 1.1450 (50% retracement) area on the radar, with a move above the 50-Day SMA (1.1460) opening up the Fibonacci overlap around 1.1490 (50% retracement) to 1.1540 (61.8% expansion).
• However, lack of momentum to hold above the 1.1290 (61.8% retracement) to 1.1310 (100% expansion) region may push EUR/USD towards the 1.1190 (38.2% retracement) to 1.1220 (78.6% retracement) area, with a break of the July 2020 low (1.1185) opening up the Fibonacci overlap around 1.0930 (161.8% expansion) to 1.1000 (78.6% retracement).

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— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong