Euro skeptics want evidence that the rally extends beyond the dollar

(Bloomberg) – Investors caught off guard by the euro’s sharp recovery from a 20-year low remain skeptical about the rally.

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Aided by a massive sell-off in the dollar following signs of US inflation cooling, the single currency is up 5% against the greenback this month, to its highest level since July. According to UBS Global Wealth Management, Russell Investments and Insight Investment, it is doubtful whether the euro can strengthen further on its own.

The coin’s brief swing on news of a missile hitting Poland shows it is vulnerable to selling if the war between Russia and Ukraine escalates. And while it could find some support if Europe avoids an energy deficit this winter, further significant impetus could be limited given signs that the European Central Bank could slow its pace of rate hikes as it takes into account the impact of the record inflation in the region. .

“The positive side of the euro is likely to end for now unless we get another wave of stronger-than-expected data or more positive news on the energy situation,” said Dean Turner, an economist at UBS Global Wealth Management. He expects the euro to struggle to sustain gains above 1.04 through the end of the year.

“We are not very confident that what we have seen will lead to a stronger rally.”

The euro has recovered by 9% from its 20-year low in September, after falling below parity in July on fears that Europe could face energy rationing in the winter. But the latest increase comes largely from deep selling in the dollar. Investors burned by premature calls to end July’s strong dollar want to see the trend take root this time before betting bullishly on the single currency.

“Market participants are a little more cautious and are willing to wait for confirmation that the dollar has peaked,” said Van Luu, head of currency and fixed income strategy at Russell Investments. They are “willing to miss the first few percent of this rally in the euro or any other currency against the dollar.”

“We’re in that camp,” he said. Russell maintains his neutral stance on the euro after the latest rally.

Technical hurdles

Technically, the single currency needs to move above its 200-day moving average at around 1.04 to move higher. Ahead, a larger resistance level looms at 1.0578, a major Fibonacci retracement of the euro’s decline from mid-2021, as the Federal Reserve began telegraphing its intent to hike rates.

At the same time, a dollar rebound may be on the horizon, as indicated by the Bloomberg Spot Dollar Index fulfilling the so-called ABC correction of a full Elliott Wave cycle since September highs.

Demand for dollar bullish calls is resurfacing. Risk reversals, a barometer of market positioning and sentiment, show that traders are now bearish against the euro after being briefly positive on the outlook last week.

While long euro positions have surged to their highest levels since mid-2021 along with the currency’s recovery, some investors may be waiting for more evidence to build an argument to aggressively sell the dollar.

“You have to respect the trend, but similarly, selling dollars after it has had a 6% move is not exactly a particularly profitable strategy historically,” said Francesca Fornasari, head of currency solutions at Insight Investment. “The dollar has probably peaked, but it’s not entirely clear that you’re going to see another big move down.”

–With help from Vassilis Karamanis.

(Updates to ECB interest rate forecasts in third paragraph.)

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