FX.co ★ EUR/USD: The moment of truth

Until recently, I was sure that the EUR/USD rate would drop to the level of 1.14, but today we must admit that not everything is as simple as it seemed at first. The EUR/USD currency pair has never been simple, and its current somersaults once again confirm its wayward nature. When trading the euro, you should always keep your eyes open, because it never lets the trader relax.

Frankly, after several years of observing the euro and the dollar, I realized that it was not possible to understand its fundamental direction. The main laws governing the exchange rate of a currency pair are Interest Rates Parity; Purchasing power parity and Fisher's equation of inflation expectations. From a fundamental point of view, the dollar, as they say, has all the cards in its hands.

Interest rate parity. USD rates are currently positive. The 3M Libor sales rate as of April 15 was 0.18975%. In turn, the 3M Euribor rate was negative and on April 15 was -0.537%. The potential of 0.71% percentage points for the current moment is quite significant. There is an even bigger difference between bonds with a longer maturity. Here, the euro loses to the dollar in all respects.

Purchasing power parity. The euro has a slight advantage here. The fact is that commodity prices are traditionally nominated in US dollars, respectively, the more expensive the dollar, the cheaper the commodity prices, and vice versa - the more expensive the commodity prices, the higher the EUR/USD rate. At the moment, commodity prices have been rising for several months in a row. However, one should not forget that they are now at 40-year lows (Fig. 1), while the dollar is not quoted at the highs, and has been trading in a range for several years now.

Figure 1: TRJ CRB Commodity Index

As can be seen from the graph of the TRJ CRB index, which includes futures exchange prices for 21 commodity assets, despite the growth of recent months, commodity prices are now even lower than they were during the market fall in 2008-2009. The commodity trend is still negative, and, despite the general fears, it is not a fact that inflation will start to rise. In the end, Western countries and the US government have been able to contain the rise in commodity prices for 10 years, and it can be assumed that they will at least try to do this trick now. In this regard, the advantage of the euro over the dollar in the commodity segment still looks dubious, but for the purity of the experiment and commodity prices I will write down the euro as an asset.

Inflationary expectations described by the Fisher equation. Here the dollar is confidently leading over the euro, March inflation in the eurozone was 1.3%, while core inflation in the US was exactly twice as high - 2.6%. This means that investors are expecting higher rates in the US, which provides them with higher profit margins compared to the eurozone. By investing in dollar assets, investors will earn more than in euros, and this ensures the demand from dollar buyers around the world.

Thus, from the point of view of fundamental laws, the dollar outperforms the euro with a score of 2: 1. However, if we take into account the initial FOREX condition stating that, all other things being equal, the investor prefers the US dollar, then the score becomes 3: 1 in favor of the US dollar. Until the last moment, the technical picture of the dollar and the euro in the EURUSD pair fully confirmed this ratio. It was not clear why the euro was above 1.20 at all. However, as my many years of practice show, the technical picture describes the course better than any other fundamental speculation.

Figure 2: Exchange Rate of the US Dollar Index against a basket of foreign currencies

First, let's look at the technical picture of the US dollar in relation to a basket of foreign currencies (Fig. 2). As follows from the diagram, from January to April, the dollar index grew by 4%, but in the first half of April it lost its advantage and is now below the level of the quarterly and semiannual moving averages, above the support level of 91.40. If the dollar closes a week or a month below the level of this support, it will open the way for it to decline to the value of 90 and, quite possibly, will be the beginning of a deeper fall in the American currency rate.

Fig. 3 Technical picture of the EUR/USD rate

As you can see, from the technical picture of the EUR/USD rate (Fig. 2), we have a mirror image of the dynamics of the dollar index in relation to a basket of foreign currencies. This is not surprising, given that about 60% of the dollar index is in the euro. As you can see from the diagram, from January to April 2021, the European currency rate lost 6% of its value and reached 1.17. At the moment, the EUR/USD rate is above the level of the average quarterly and semi-annual values, reaching resistance at 1.1980, which can be roughly rounded to the level of 1.20. If the European currency manages to close the week or April above the level of 1.20, this will mean an actual breakdown of the downward trend, and then the euro will again open up growth prospects to the levels of 1.22 and 1.24, and possibly even higher.

As we can see from the fundamental analysis, the dollar has an advantage over the euro. However, technical analysis does not allow us at the moment to draw conclusions and sell the euro against the US dollar, although again we can see another sign of the euro's weakness, which from January to April fell against the dollar and other currencies to a greater extent than the dollar rose to the euro.

Here you can tell readers for a long time about the fact that vaccination in Europe and Japan is shockingly lagging behind the United States, where America is ahead of the rest, that the United States is recovering from the crisis faster than the Eurozone, but the graph shows everything we need to know. The current recovery in EURUSD is by no means over and could lead to tipping points, regardless of how the US and Eurozone economies feel. Be careful and follow the rules of money management.