Foreign Exchange - Euro Holding On:Regular readers, and those with a technical bias, will know we that have been talking about a long-term head and shoulders pattern forming on the monthly EUR/USD chart. Well, as we have been saying for a few weeks, the 1.1800-1.2000 area is growing in importance. It was our initial target when we became bullish on the dollar above 1.2800.
The longer EUR/USD holds this key area, the greater the chance of a move to the upside. At the moment, strong resistance exists in the 1.2250-1.2300 region. However, if the exchange rate were to push through this area, it could well rally to 1.2500, and possibly even the 1.2700-1.2800 mark. This would tie in with our view of the formation of the right shoulder - that is, some short-term euro strength, before the dollar reasserts itself in a larger fashion, with a medium-term move back towards 1.0000.
The short-term euro bounce scenario ties in with much research that we have read over the past week, which points to the improving economic data in Germany and the likelihood of the US trade deficit widening after several months of contraction. The argument goes that as the US economy continues to grow strongly, the trade deficit will surely worsen in the months ahead, especially as imports pick up after a period of de-stocking by producers and retailers. The recent rise in the price of oil further compounds the situation. We like this argument, also because it ties in with our technical view. From a purely market perspective, the dollar has failed to make further headway lately through 1.2000 despite all the good news in its favour.
However, there are two sides to every exchange rate. And because the US economy is in far greater shape than its euroland counterpart, we are adhering to this view of dollar revival after a period of weakness. Sure, the German economy is showing signs of life, but it is too difficult as yet to tell whether the recovery is sustainable, and much depends on the upcoming election result to gauge the strength of the reform programme. Moreover, interest rate differentials will continue to favour the dollar. Ok, so the current account deficit is a concern. We acknowledge this, and it is a clear risk to our view. However, even if it worsens from current levels, which we think highly likely, we still believe that foreign central banks and investors will continue to purchase US assets, thereby financing the shortfall. At this stage, we feel that the medium-term economic risks are greater for euroland than the US.
In the meantime, as we say above, the euro could well offer a short-term upside surprise, which will serve to make the dollar more attractive.
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