Euro Shifts to Sell-the-Rally Mode as Fed, Italy Alter Outlook

(Bloomberg) -- While it’s not yet time to go all-out bearish on the euro, Europe’s political disquiet and persisting monetary-policy divergence versus the U.S. suggest the common currency may have seen a short-term top.

The euro hit a two-week low Friday after Italian political risks resurfaced, a day after the Federal Reserve raised interest rates for the third time this year and Chairman Jerome Powell kept a hawkish tone during his press conference. While sell-stops in the cash market have already been triggered as the shared currency dipped below $1.17, the move lower may extend as the short-term technical outlook shifts and option traders remain bullish on the dollar.

Momentum investors have jumped on the euro-selling wagon, looking to add to short positions on downside breaks of key technical levels, according to three traders in London and Europe, who asked not to be identified because they are not authorized to speak publicly.

Near-term positioning is neutral to dollar-short, in contrast with longer-horizon allocations, the traders said. Such stale euro longs may come under additional pressure as the market awaits tier-one data out of the U.S. next week, including the September payrolls report.

Data, Politics

Analysts are looking for another robust U.S. employment report with additional signs of wage price pressures, while also keeping an eye out for the European Commission’s reaction on the Italian budget. As euro-area politics dominates market narratives once again, traders may assign more value to headlines out of Germany and any signs that Angela Merkel’s leadership is under challenge.

Euro losses since Thursday may have been fueled by European dynamics, yet it was the Federal Open Market Committee that helped reaffirm the common currency’s topping out near $1.18.

As eurodollar contracts show a paring of bets for a U.S. recession, markets remain behind the curve when it comes to the Fed’s dot-plot projections -- pricing suggests traders assign only a one-in-five chance that policy makers will go ahead as planned with further tightening.

That suggests the U.S.-Europe monetary-policy divergence may actually have room to widen, given the European Central Bank has repeatedly emphasized that its first rate increase is seen only after the summer of 2019 amid core inflation readings that remain well below target.

Technical Outlook

Current market forces don’t seem sufficient to push the euro below the $1.15 handle given that President Donald Trump remains a critic of Fed policies and may adhere to verbal intervention once more, while the U.S.-China trade war may not spread across the globe.

Still, the shared currency is now technically on sell-the-really mode, with momentum indicators pointing lower and the Bloomberg Trender Indicator suggesting a bearish trend on closes below $1.1796. Should the 55-daily moving average at $1.1621 give way on a closing basis, the euro may target the $1.1526-$1.1530 September double bottom.

What to Watch:

• U.K. Conservative Party’s annual conference starts Sunday, Sept. 30; Prime Minister Theresa May speaks Oct. 3
• U.S. President Donald Trump must sign by the end of Sunday multiple spending bills passed by Congress to avoid a government shutdown
• Policy makers’ speeches include Fed Chairman Jerome Powell, Fed Vice Chairman for Supervision Randal Quarles, Atlanta Fed President Raphael Bostic, Chicago Fed President Charles Evans, Boston Fed President Eric Rosengren, ECB Executive Board member Yves Mersch, ECB Governing Council member Olli Rehn, BOE chief economist Andy Haldane
• Economic releases include euro area manufacturing PMI, U.K. services PMI, U.S. payrolls ans ISM manufacturing; see data calendar
• NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

To contact the reporter on this story: Vassilis Karamanis in Athens at vkaramanis1@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Anil Varma, Scott Hamilton

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