Euro Rally’s Just Warming Up as Charts Signal Rise to $1.25

(Bloomberg) -- An advance that sent the euro to the highest since 2018 has put a move above $1.25 back into focus. It’s a level that has eluded the currency for most of the past six years.

Chart patterns, including the so-called inverted hammer and the Elliot Wave, show the euro is likely to breach the all-important level. The currency is also being buoyed by a vote of confidence in the European Union’s timely response to the pandemic, as well as a revival in reflation trades that have kept the dollar under pressure.

“There’s little in the way of technical resistance until highs from back in early 2018,” said Lee Hardman, a strategist at MUFG in London, who sees the currency rising to as high as $1.25 in the near term. That’s a 2.8% advance on Friday’s level of $1.2150.

The euro’s 8.4% gain versus the dollar this year is set to be the currency’s biggest since 2007, after a more than 14% jump in 2017. Its fortunes improved when swift responses by European governments to the spread of the coronavirus, unprecedented stimulus programs and a rescue package that included the sale of joint bonds bolstered the currency’s appeal.

Over the past few weeks, it stalled but then broke through the $1.20 handle, a level that prompted verbal intervention by European Central Bank officials in September. A similar pattern was seen after the French election in 2017, which culminated in a break above $1.25 early the following year.

“We have to give it a bit more rope than we otherwise might,” given the market is re-pricing risk factors, said Ned Rumpeltin, European head of foreign-exchange strategy at Toronto-Dominion Bank. “It’s interesting that in contrast to earlier this summer, we have not heard any real signs of protest from the ECB.”

Caught Off Guard

Analysts weren’t expecting the euro to reach these levels until the end of 2021, and investors were caught off guard. Options traders were short volatility on the euro above $1.20, meaning they had to buy the euro every time it hit a new high this week. At the same time, CFTC data show leveraged investors had flipped back being short the euro and were caught out by the latest rally.

That’s because there’s a case for the euro to give back some of its gains. Latest data show the euro area may be slipping into another contraction due to recent lockdowns. It could spur bets that the European Central Bank may cut interest rates, which would weigh on the currency.

And given the currency’s low volatility, the euro may become attractive for carry traders once again, especially those investing in emerging-market currencies, a reason why it fell in the two years through 2019.

For now, bullishness on the currency, which capped its best November against the dollar since 2006, is strong. The so-called volatility skew, which depicts the relative cost to buy directional volatility, shows that options that pay out should the euro strengthen trade at their widest premium since early September.

In addition to the favorable macro picture, bullish options and charts, the euro may also be boosted by global reserve managers’ demand that could shift further away from the dollar next year.

©2020 Bloomberg L.P.