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This is the second day of very tight ranges that we have seen in FX markets. Yesterday's action could be put down to the markets taking a breather after Thursday and Friday's rally from last week, however today's price action could be put down to nervousness ahead of major event risks due this week.
Europe back in focus
The first is all euro-based. Tomorrow sees the EU Commission's State of the Union address, Dutch elections and it kicks off with a 0900 BST decision from the German Constitutional Court on the legality of the ESM rescue fund. There was some expectation that this decision could be delayed, but the vote was confirmed earlier this morning. That helped the euro to rally back above 1.2810, but for a second straight day 1.2820 has kept a lid on gains. There is a risk now that this could be a double top. We think it all depends on the FOMC decision on Thursday as the future direction of markets, including the FX market, lies in the hands of the world's major central banks.
This brings me back to the FOMC decision. In the past the anticipation of QE has moved the markets more than the actual announcement. Back in 2010 EURUSD rallied more than 8% in the lead up to the announcement of QE2, but then EURUSD lost nearly half of that gain in the immediate aftermath of the decision before going on to rally another 20% over the next 9 months. So the outcome of QE is not that straight forward for FX. If the Fed does announce a huge QE programme (i.e., open ended purchases) then we could see the dollar spike lower. However, if it announces something like it has before then we could see EURUSD sell off, maybe back to 1.26 in the short-term, which is also the 100-day sma.
QE and its effects on the market
Compared to 2010, EURUSD is at a weaker starting point today. Post the ECB bond-buying plan announced last week I see further EURUSD downside as fairly limited, even if the Fed doesn't placate the market with its policy decision next week. The trouble is QE won't solve the US's growth problems or the fiscal cliff that we is expected at the start of next year. Thus, lacklustre economic growth could keep USD gains capped in the long term. However, growth in Europe doesn't look like it has reached a bottom yet and sovereign concerns could return, so we don't see a strong euro in the medium-to-long term either. In the next three months we could see EURUSD back below 1.25, but I don't see a protracted down move in the cross back below 1.20 as we saw in June 2010.
Elsewhere, the UK registered much stronger trade data for July after a 9% jump in exports, while imports fell 2%. Exports rose by 9.3% in July, which is the biggest monthly increase since January 2003. Trade has been a drag on UK growth for most of this year, but it could boost GDP in Q3. The increase in exports was led by oil and chemicals. Although EURGBP remains at record lows the trade deficit with the Eurozone also fell in July. This helped to boost sterling, but gains remain capped at 1.6030 for now, and we see the future direction of this pair being determined by the FOMC and also the outcome of European events due tomorrow.
One to Watch: EURUSD: it could be a choppy week ahead with the FOMC meeting. Key levels to watch include 1.2780 - the Ichimoku cloud base - which should act as good support in the case of a prolonged downtrend. Below here support also lies at 1.2650. On the upside, above 1.2840 opens the way to 1.2935.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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