The single currency is looking extremely weak today. It has fallen to as low as 1.3057 and is being battered by the perfect storm of political risk, technical factors and holiday-thinned markets.
In fairness the breach of the 1.3150 level earlier today that has left EURUSD at its lowest level since January is no surprise. On a long-term basis the cross had made a series of lower highs since trying but failing to break above 1.50 in May. First it was 1.47, then 1.45, 1.42 and the recent decline saw 1.38 and 1.35 get taken out fairly quickly, now 1.3150 has been breached. After some congestion around the 1.42- 1.45 zone, EURUSD has been on a clear downtrend for the last two months. But the question to ask is where will this cross go now?
The trouble with the single currency is that it is incredibly resilient and tends not to fall in a straight line, instead we have seen it embark on a slow grind lower. Because 1.30 is such an important psychological level and the market is already short of dollars (the most short it has been since mid-2010) then we could see some stickiness around this level.
However, in the medium-term we think that EURUSD could be heading for the mid-20's.There are both fundamental and technical factors supporting this.
· The trigger to the decline in the euro today was comments from German Chancellor Merkel. She said that the ESM - the Eurozone's long-term rescue fund - would not see the upper limit of its funds raised. The ESM is EUR 500bn in size, which isn't enough to cover Italian and Spanish liabilities in the medium-term if they get into trouble.
· Added to that Merkel has also reiterated that the ECB will not act as the currency bloc's lender of last resort and there will be no mass buying of sovereign debt by the Central Bank. This is considered the only solution to ease the near-term risks of this crisis, so understandably investor sentiment has dipped on these comments. So political risk is a major concern for euro bulls right now.
· There was a lot resting on last week's EU summit and as the market digests the result they have found the solution wanting and there has been that very little done to deal with the current brevity of the situation.
· Added to the political risks, growth is weak and there is a large sovereign downgrade risk for the entire currency bloc.
· Of course, some of the peripheral countries may want a weaker euro to boost their exports and re-balance their economies - so a weaker single currency could actually help relieve the debt crisis...
· We have known for years now that the fundamentals of the currency bloc were weak, but the euro remains a resilient currency.
· However, the technical indicators suggest that the Euro is losing some of this resilience. Added to this, when liquidity is thin momentum can build very quickly.
· EURUSD is below its daily Bollinger band and it is also below the base of its daily Ichimoku cloud chart, which suggests a firm downtrend is emerging.
· The longer-term and shorter-term directional indicators all point lower including the MACD and RSI on the daily chart and the 30-minute chart, suggesting that downward momentum is building.
· 1.2860 is the 100% retracement of the 1.4940 high reached in early May. This could act as good near-term support if we get below 1.30.
· In the very near-term 1.3050 and 1.3022 could act merely as resting places if the bears manage to break this key psychological level.
So to conclude, as we have already pointed out, a break of 1.30 suggests that the Eurozone debt crisis has reached a critical level, but in the long-term a weaker currency is just what the stressed peripherals need.
Of course there is a chance that a dovish Fed or even QE3 from the US next year could keep a lid on EURUSD losses. EURJPY is probably a purer play on euro weakness, but this pair is also at risk from currency intervention by the Japanese authorities. So short-term bearish strategies are the way to the trade the euro in our opinion, especially since the market is so short the euro already and central bank reserve diversification has been a good support for the euro in the past.
So the euro may be breaking down, but we have been here before, so tread carefully. There are likely to be plenty of short- squeeze rallies as we head into year end, especially since the market is so short euro already, so there could be better levels to enter a short euro trade for those who are patient enough to wait.
EURUSD: daily chart with MACD and RSI and Fib retracement. This cross has made a series of lower highs since peaking in early May. Support could come in at 1.2860 - the 100% retracement from the 1.4940 high.
EURUSD has also broken beneath its daily Bollinger Band, a key bearish signal.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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