Euro Bulls Emboldened

It took six attempts for the euro to break the $1.1300 resistance level this month. One day after breaching the barrier, the common currency is fast approaching the next line in the sand amid a rally that now has analysts pondering what it will take to slow the best-performing major currency this quarter.

For chartists from JPMorgan to RBC, there are few obstacles remaining before the euro lifts off in a sustained rally amid fading political risks and a monetary policy shift on the horizon. With the $1.13 post-U.S. election high giving way, $1.1428, a level last reached as traders awaited the result of the U.K.'s vote to leave the European Union a year ago, remains one of the last lines of defense for euro bears before the common currency advances to the $1.17 area last seen in August 2015.

“The November high was really important and we did push through it,” said Niall O'Connor, a technical analyst at JPMorgan. “If we do break through the $1.16-17 zone, there's really not a whole lot of resistance. We'll start talking about a bigger base breakout for the euro.”

Traders brushed off suggestions by European officials Wednesday that the market misread remarks from European Central Bank President Mario Draghi a day earlier in which he downplayed deflation risks and opened the way for paring monetary stimulus. The common currency climbed 0.4% to $1.1379 as of 1:04 p.m. New York time, after it reaching as high as $1.1391. It gained as much as 1.49% on Tuesday.

Draghi's “comments are a hawkish surprise and now set up expectations of an ECB tapering announcement in the fall,” Marvin Loh, senior global markets strategist at BNY Mellon, wrote in a note to clients.

Quantitative easing has held the euro down as the ECB keeps a negative deposit rate and continues to purchase domestic bonds to buoy asset prices. But with normalization on the horizon and political risks fading, the currency has rebounded 7.8% this year and gained against all of its G-10 peers. As the economy recovers, banks such as HSBC and UBS expect the euro to embark on a dollar-esque rally in the coming year.

To George Davis, chief fixed-income technical analyst at the RBC Dominion Securities, Tuesday's breakout past $1.13 is revealing and consequential, given that the level was tested several times before being breached.

“If someone's got a medium to longer term horizon, the price action we've seen in the past few weeks and especially today basically suggests that your bias would be to play the euro from the long side, using pullbacks down towards the $1.115 area as buying opportunities,” Davis said.

The euro moved sharply after Draghi's comments, suggesting that investors were caught off guard as to the possibility that his speech could rattle markets. Commodity Futures Trading Commission positioning shows that hedge funds are just slightly short the euro and at levels far below their five-year average. Should the current rally continue, wrong-footed investors could accelerate the upward move, analysts from ABN Amro wrote in a note Tuesday.

Deutsche Bank raised its euro forecast to $1.16 or above by year-end, up from $1.03 previously, strategist George Saravelos wrote in a note. He argued that Draghi's speech wasn't the fundamental driver behind the change in view but it aptly marked the culmination of a number of developments that have caused the forecast update.

Yet technical levels aside, there are a few fundamental barriers that could cap the euro's rise, the ABN Amro analysts, led by Nick Kounis said. If U.S. economic data begin to surprise on the upside, breaking a string of disappointing releases, some downward pressure on the dollar may ease. The euro may also run out of steam if Federal Reserve speakers succeed in convincing the market that they'll stick to their rate hike path, the analysts wrote.

Bloomberg News

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