HomeMarketingIn spite of short-covering, the EUR/USD remains vulnerable

In spite of short-covering, the EUR/USD remains vulnerable

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In spite of a brief covering in the market, the EUR/USD remains vulnerable. The Euro has been dragged lower by a combination of growing worries about new tariffs on European goods, fueled by trade tensions with China and concerns about nuclear talks between North Korea and United States. The U.S dollar index has been knocked back to near 1-month low after President Trump tweeted that he would impose 10% tariffs on all Chinese imports to the United States if Beijing failed to make significant progress towards achieving a trade deal with Washington by Friday.

The ongoing trade war with China that was started by the Trump administration is likely to put pressure on the European Central Bank (ECB) to keep lowering its interest rates. A rate cut, or even an announcement of a rate cut, would be seen by investors as an effort to stabilize the market. With turmoil in Asia and political tensions between Washington and Brussels heightening, a strong U.S dollar could potentially help Europe lower borrowing costs. The ECB has been more cautious in monetary policy since the financial crisis, and therefore more susceptible to U.S monetary policy changes.

Bullish Scenario

The most likely outcome of the trade war is that it will push China and Europe closer to each other. The already weak Chinese economy is being adversely affected by the tariff war. A large number of import-dependent industries have come under pressure, and there is a risk of a double-whammy for the Chinese economy with an even weaker Eurozone, which would amplify the negative effects of a slowing Chinese economy. A bigger EU market for German exports could in turn help EU companies gain from increased demand which would then lead to lower borrowing costs. The current environment of uncertainty could pull the pair lower. The single currency will have to overcome its psychological support of $1.17 and reach a new low by the end at least for this year.

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Bearish Scenario

On top of trade tensions, political uncertainties in Europe could also lead to further downward pressure on the Euro. In particular, concerns over Italy’s budget plans could undermine recent gains in Italian bonds and strengthen the Euro by increasing demand for safe-haven assets i.e., the U.S dollar and gold. There are also risks that an increasingly isolated the United States could turn to other trading partners following an EU-U.S trade war. It is possible that an EU-Japan trade deal could gain momentum, threatening exports of German cars to the U.S market.

The Euro will have to reach $0.80 at least for this year in order to regain some of its losses from the week. The coming weeks will be important i.e., whether a further breach of support for 1.17 dollars is seen as more bearish than bullish, or whether it is instead viewed as a temporary holding position. We have already seen that the EUR/USD could potentially retest that psychological level and if such an upward trend were to continue, the price of the single currency could reach 1.30 over the next few weeks,.

What influences the price of the EUR/USD?

-Global economic and political outlook: The economic outlook for Europe is closely intertwined with that of the United States, Asia and Canada. For example, if growth in these countries were to slow down, this would negatively affect demand for European exports and prompt investors to sell Euros, thus lowering its value relative to other currencies.

-Budget policies: Policy decisions by individual European countries are often transmitted to the Euro price. An example of this is the Italian budget policy that, in April, provoked a sharp sell-off and formed part of the backdrop for a drop in the price (see graph)

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​-Technically: the EUR/USD acts as an indicator of future expectations regarding interest rate levels. For example, if investors expect a rise in interest rates and therefore increase demand for U.S dollars, the exchange rate will appreciate.

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