Euro Q3 2022 Forecast

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Euro Q3 2022 Forecast: Euro May Fall Anew as Debt Crisis Fears Dilute ECB Rate Hikes

Jul 2, 2022 | DailyFX
Ilya Spivak, Head Strategist, APAC

The Euro has steadily depreciated against a basket of major currencies since Dec. 2020. Tellingly, that turning point coincided with topping gold prices and the start of a creep higher in Fed rate hike expectations. The US central bank had signaled it was done adding to Covid-inspired stimulus measures.

Not surprisingly, the overt start of the Fed’s tightening effort in June 2021 marked the beginning of the deepest drop along this bearish trajectory. The markets reckoned the ultra-dovish ECB would not be as quick to follow the US lead as many other top central banks, pushing yield spreads against the Euro.

EURO DOWNTREND STALLS AS ECB RATE HIKE BETS SURGE (WEEKLY CHART)

Source: TradingView

Then, in the second quarter of 2022, European officials finally signaled a readiness to act as regional CPI inflation roared to record highs. It would go on to hit an eye-watering rate of 8.1 percent in May. The Euro found a floor and began to inch upward as rate hike expectations began to be absorbed into prices.

EURO DEBT CRISIS FEARS RETURN AS THE ECB PREPARES TO FIGHT RECORD-HIGH INFLATION

Speculation culminated on June 9, as the ECB formally announced incoming interest rate hikes. The central bank previously said it would end bond purchases – a form of non-standard stimulus – in July. Less than a week later, an emergency meeting was scrambled and a mandate given to create a new tool against ‘fragmentation.’

That stopped the Euro’s ascent in its tracks. ECB tightening expectations revived worries about high levels of debt in some Eurozone economies. The spread between Italian and benchmark German 10-year government bond yields widened sharply to a two-year high of 242 basis points (bps) after June’s policy meeting.

Managing ‘fragmentation’ – that is, diverging lending rates across Eurozone states – now seems like it will necessarily keep ECB tightening modest relative to global peers. That puts the single currency at an acute disadvantage, suggesting the downtrend is due to resume.

FISCAL REFORM COULD UNCHAIN THE ECB, BUT IT’S PROBABLY NOT COMING SOON

The kind of structural reforms needed to untie the ECB’s hands – creating a joint “Euro-bond” or finally slashing debt levels in southern Europe – seems distant at best, if only because the critical Franco-German push needed for progress is a tall order. Berlin and Paris are likely to be focused on other priorities.

The war in Ukraine and its implications for regional geopolitical and economic stability – most pressingly, the challenge it poses for securing energy supply at a reasonable cost without reliance on Russia – are clearly front-of-mind. Disruption of trade with a key market in China amid that country’s Covid-driven lockdowns is another worry.

A hamstrung administration in the Eurozone’s number-two economy complicates fiscal matters further. French President Emanuel Macron managed to win another term in office, but his coalition lost its majority in the legislature. This means that the fragile government will struggle to get anything big done in the next five years.

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Euro Q3 2022 Technical Forecast: EUR/USD Carves Out Bullish Reversal Pattern, But Caution is Warranted

Jul 3, 2022 | DailyFX
Diego Colman, Market Analyst

EURO PRICE ACTION IN BOTTOMING-OUT PHASE?

The euro continued to lose ground against the U.S. dollar in the second quarter, extending the relentless decline that began just over a year ago. There are several factors behind the recent sell-off, but the most important have been the divergence in monetary policy between the Fed and the ECB, the fallout from the Ukraine war and negative market sentiment.

In the past three months, EUR/USD marked a new multi-year low near 1.0350, a key technical zone that has acted as support on several occasions in late 2016 and early 2017, as shown in the weekly chart below. The pair probed this floor twice during Q2, first in May and then in June, although the bears were unable to create a lower low on the second test amid weakening downside pressure, a sign that prices may have bottomed out around those levels.

Although the long-horizon bias remains bearish, there are some indications that the worst may be over in terms of losses for the common currency, at least in the near-term, creating an attractive set-up for traders who like to play "trend reversal" strategies.

EUR/USD WEEKLY CHART

Chart created using TradingView

DOUBLE BOTTOM PATTERN IN PLAY FOR EUR/USD

Zooming in on the daily chart, it appears that EUR/USD is carving out a double bottom, a bullish reversal technical formation that tends to develop near the nadir of a well-established downtrend while the overall market is volatile.

The double bottom, which develops in the shape of a letter “W”, is composed of two consecutive and similar troughs, divided by an intermediate peak, the pattern’s neckline, where prices, after rallying off the first valley, encountered resistance before pivoting lower on its way to set the second low. In our case, the neckline sits near 1.0760/1.0785.

Heading into the third quarter, the double bottom is nearing completion and confirmation, with EUR/USD advancing towards the neckline, a major resistance, the break of which could give a solid bullish signal. We are not there yet, but 1.0760/1.0785 can be considered the line in the sand, so to speak.

Focusing on the outlook, if EUR/USD manages to punch through the neckline decisively on higher-than-usual volume, the upside momentum could strengthen, setting the stage for the pair to challenge trendline resistance near 1.1100, followed by 1.1195, the 38.2% Fibonacci retracement of the 2018/2022 decline.

Many things will have to go right for this scenario to play out, but the bullish case should not be dismissed despite the pessimism towards the euro.

On the flip side, if the euro stalls, resumes its descent and revisits the 2022 lows, the double bottom pattern would be invalidated, especially if prices breach the floor in question and make a new low. In the event of a sustained drop below 1.0350, all bets are off. There is no significant technical support underneath this area, so EUR/USD could be on its way to parity if 1.0350 is violated.

EUR/USD DAILY CHART

Chart created using TradingView