Sun, Nov 27, 2022 @ 14:38 GMT
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Forex Friday: Dollar, Yuan and Euro

Welcome to Forex Friday, a weekly report in which we discuss selected currency themes mainly from a macro viewpoint, but we also throw in a pinch of technical analysis here and there.

In this week’s edition, we discuss the dollar, yuan and euro, and look forward to the week ahead.

  • Dollar sold too far, too fast?
  • USD/CNH and China concerns rise
  • EUR/USD tests 200-day
  • EUR/JPY eyes breakout
  • Key data to look out for in coming week

Dollar sold too far, too fast?

US investors will come back from Thanksgiving holiday – well, at least some of them anyway – and will realise they didn’t miss anything. Perhaps we might not see too much movement today given a quieter macro calendar. But China concerns are on the rise with covid cases hitting record levels. This could potentially trigger a risk-off response. Otherwise, investors will look ahead to a busy week for macro data, which will include the publications of US GDP and non-farm payrolls reports. Fed Chair Jerome Powell will also be speaking on Wednesday.

If Powell re-iterates the Fed’s commitment to bringing inflation down through further rate rises and mentions that one or two inflation reports are not enough to suggest the Fed’s job is done, then this could trigger a dollar recovery.

As mentioned, there will be lots of macro data to look forward to next week. US GDP is among those on Wednesday. The world’s largest economy grew at an annualized pace of 2.6% in Q3, beating forecasts of a 2.4% expansion and rising from two quarters of negative growth. Clearly, the US has been holding its own much better than some other regions in the world but faced with mounting evidence that the consumer is weakening amid hot inflation and interest rate hikes, the economy faces a bumpy road ahead.

The other big data release will be US non-farm payrolls report on Friday. While concerns over a potential recession are on the rise, the Fed has so far been reluctant to hit the brakes on rate hikes because of a healthy jobs market. The economy added a stronger-than-expected 261K jobs in October, which was well above forecasts and September’s numbers were revised higher. But if hiring slows down sharply then this could raise recession alarm bells, causing a re-think at the FOMC.

So, after a big drop, the Dollar Index will remain in focus. Investors will ponder whether they have sold the dollar too much in an overall still-positive macro backdrop for the greenback. The Fed is still tightening its policy and big macro risks remain elevated for Eurozone, China and elsewhere. A toxic mixture of still-very high inflation across the world and anaemic growth should keep the appetite for risk taking to a limit from here on.

USD/CNH and China concerns rise

It is worth watching the USD/CNH as it is showing strength again (yuan is weakening). This is hardly surprising given the risks the yuan faces from the latest wave of Covid cases in China and the move by the PBOC to cut banks’ reserve requirement ratio by 25 bps.

The world’s second largest may have tighten its Covid curbs even further because of the current wave of Covid. Cases have risen to levels last seen in April, when Shanghai was put in a stringent lockdown. Although China relaxed some restrictions, its zero covid policy means the threat of more growth-choking lockdowns are there. This is going to hold back the yuan and potentially risk assets across the board.

Now, the USD/CNH is trying to break away from the key 7.1700 – 1.1800 resistance area. A daily close above here could pave the way for a run towards the next resistance around 7.2293, the base of the recent breakdown.

Meanwhile, if resistance holds, then the next support is seen around 7.1100, followed by 7.1000. If we get there and that level breaks down, then the long-term bull trend line will come into the focus again.

EUR/USD tests 200-day

The EUR/USD is testing its 200-day average, along with several other risk assets out there, which begs the question do we see a return back to the existing trends that dominated the markets for much of the year? Or at least, a retracement against this up move?

The key data as far as the Eurozone is concerned is probably CPI on Wednesday. Inflation is everywhere and still very hot in the Eurozone, where CPI stands at over 10% on an annual basis. This is a record high and well above the ECB’s 2% target. Surging energy prices had been exacerbated by euro weakness. However, both energy and the USD/EUR exchange rate have fallen of late, and there is optimism in the air that peak inflation has been reached. The sub-indices from the manufacturing and services PMIs and from several other Eurozone data points all suggest price pressures are waning. But a recession seems unavoidable. Still, the ECB will have to continue raising rates, even if we see a sizeable drop in CPI.

For now, supported by expectations the Fed is going to reduce the pace of policy tightening, the EUR/USD has risen to around the 1.04 handle, after recently it recaptured 1.0340, which was the 2017 low. But will that remain the case as traders decide whether to push rates decisively above the 200-day average from here, or re-assess the situation again?

Among the upside targets, last week’s high comes in at 1.0481; then there is the 1.0500 handle slightly higher, and finally the 1.06310-1.0638 range, an area which marks the convergence of the 38.2% Fibonacci retracement level with the March 2020 low.

On the downside, key short-term support is seen around 1.0300-1.0310 area, below which there’s not much until the 1.02 handle.

The case for a long-term low was made when rates refused to stay below the 1.000 level after several weeks of sideways action.

We will re-establish our long-term bearish view if and when the bears manage to push rates below parity decisively and specifically below 0.9935. Any short-term weakness in the interim should be treated with caution given the recent breakout.

EUR/JPY eyes breakout

Here’s one for the more technically focused traders: the EUR/JPY is about to break out soon, but in which direction?

It is true that the euro carries some positive yield over the yen. With the ECB determined to get the 10% inflation back down by aggressive rate increases, the disparity between Eurozone and Japan monetary policies are likely to grow larger over time. This is something that should help provide a floor for EUR/JPY in the long-term outlook.

But in the short-term, especially with the USD/JPY moving lower, we could see some weakness in the EUR/JPY and other yen pairs. Also, much of the interest rate disparity is already priced in. And with the eurozone economy on its knees, there is a risk that the ECB might end its hiking cycle quicker than expected, reducing the appeal of the single currency over the safe-haven yen.

The EUR/JPY actually formed a bearish engulfing candle on the daily chart on Wednesday, and we saw some downside follow-through today. The selling then came to a pause as rates tested support and the bullish trend of the triangle pattern around 143.80.

The upside was capped by the bearish trend line and resistance circa 146.00. Shorter-term resistance is seen around 144.65 to 145.00 range.

Thus, conservative speculators may wish to wait for price to break out of this triangle consolidation pattern and trade in the direction of the breakout.

Key data to look out for in coming week

Europe:

  • Monday: ECB President Lagarde Speech and German Retail Sales
  • Tuesday: CPI estimates from Germany and Spain
  • Wednesday: Eurozone CPI Flash Estimate and German Unemployment Change,

North America:

  • Wednesday: ADP Non-Farm Employment Change, Prelim GDP, JOLTS Job Openings, Pending Home Sales and speech by Fed Chair Powell
  • Thursday: Core PCE Price Index, Unemployment Claims, ISM Manufacturing PMI, Personal Income & Spending and Construction Spending
  • Friday: US Non-Farm payrolls and Canadian jobs report
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