The EURUSD rally has been driven by a number of factors, including shrinking divergence in economic growth, strong demand for pro-cyclical currencies, improving global risk appetite, and other factors. However, it is worth considering whether the euro has risen too high. Let’s discuss this issue and make a trading plan.
The article covers the following subjects:
Highlights and key points
- The euro benefited from its pro-cyclical currency status.
- The US dollar has replaced the yen as the funding currency in the carry trade.
- Buying rumors may end up harming the EURUSD pair.
- The level of 1.111 is critical for the euro.
Weekly US dollar fundamental forecast
The higher the euro goes, the more dizzying it gets. Despite opening long trades at 1.1015, it seems that EURUSD bulls are being lured into a trap. Indeed, the chances of a 100bp cut in the federal funds rate in 2024 look exaggerated; the US equity indices cannot grow indefinitely, and the US economy is not weak enough to sell the greenback. However, what if the situation is exactly the way it seems to be?
Apparently, the main reason for the EURUSD’s 4.3% rally since mid-June is not the strength of the euro. The currency bloc’s leading economy, represented by Germany, contracted in the second quarter, and European economic data for August is likely to show stagnation. Against this backdrop, the euro clearly lacks bullish strength. The main reason lies in the outright weakness of the US dollar.
Indeed, fears of a recession in the US have faded, but the slowdown in US GDP is evident. Citi’s US Economic Surprise Index is falling faster than its counterparts from other countries, implying that the divergence in economic growth is narrowing. The UK has already overtaken the US in the first half of the year, and now it is the rest of the world’s turn. In such an environment, pro-cyclical currencies tend to thrive, so it should come as no surprise to see the pound and the euro in first or second place in the G10 currency race.
G7 economies’ performance
Source: Bloomberg.
At the same time, the greenback is suffering as a safe-haven asset amid improving global risk appetite. US stock indices are soaring, buoyed by the Goldilocks scenario and expectations of a 100 bp cut in the federal funds rate in 2024 and a further 100 bp cut in 2025. As a result, borrowing costs risk falling to 3.5% from 5.5%, which would be a tailwind for a massive sell-off in the US dollar.
The riskiest carry traders are already using the greenback as a funding currency. According to Citi research, the carry trade strategy is back, but the yen is left uninvolved at this time. Funds are being borrowed in US dollars and allocated in the currencies of developing countries. This is not surprising, given the high level of global risk-taking.
Global risk appetite
Source: Bloomberg.
Thus, reduced divergence in economic growth, the popularity of pro-cyclical currencies, the markets’ confidence in aggressive Fed rate cuts in 2024-2025, improving global risk appetite, and the use of the greenback as a funding currency in carry trade operations allow the EURUSD pair’s traders to enjoy the uptrend.
Weekly EURUSD trading plan
However, buying rumors such as rate cut signals in the FOMC minutes, Jerome Powell’s dovish rhetoric in Jackson Hole, or weakness in the US August employment report could cost EURUSD bulls a penny. If the pair falls below 1.111, it may see a short-term sell-off.
Price chart of EURUSD in real time mode
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