(Bloomberg) — Investors caught off guard by the euro’s sharp recovery from a two-decade low remain skeptical that the rally has legs.
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Helped by a massive selloff in the dollar following signs of cooling U.S. inflation, the single currency rose 5% against the greenback this month to its highest level since July. What is in doubt is whether the euro can strengthen further on its own, according to UBS Global Wealth Management, Russell Investments and Insight Investment.
The currency’s brief swing after news of a missile strike on Poland shows it is vulnerable to a sell-off if the Russia-Ukraine war escalates. And while it could find some support if Europe avoids an energy shortage this winter, a further, significant boost could be limited given signs the European Central Bank may slow the pace of interest rate hikes as it considers the impact of record inflation in the region.
“The euro’s rally is likely to have run its course for now, unless we get another burst of stronger-than-expected data or a more positive stream of news on the energy situation,” said Dean Turner, economist at UBS Global Wealth Management. He expects the euro to struggle to hold gains above 1.04 until the end of the year.
“We don’t have a lot of confidence that what we’ve seen will translate into a stronger rally.”
The euro recovered 9% from a 20-year low in September after falling below parity in July on fears that Europe could face energy cuts in winter. But its latest leg comes mostly from deep selling in the dollar. Investors who were burned by premature calls for an end to the strong dollar in July want to see the trend take root this time before making bullish bets on the single currency.
“Market participants are a bit more cautious and willing to wait for confirmation that the dollar has peaked,” said Van Loo, head of currency and fixed income strategy at Russell Investments. They are “willing to miss the first few percent of this rally in the euro or another currency against the dollar.”
“We are in that camp,” he said. Russell stuck to his neutral position on the euro even after the latest rally.
Technically, the single currency needs to break above the 200-day moving average around 1.04 to go higher. Beyond that looms higher resistance at 1.0578, a key Fibonacci retracement of the euro’s decline since mid-2021 when the Federal Reserve began telegraphing its intention to raise rates.
At the same time, there could be a rebound for the dollar, as signaled by the Bloomberg Spot Dollar Index, satisfying the so-called ABC correction of a full-cycle Elliott wave after the September highs.
Demand for bullish dollar calls is re-emerging. The risk reversal, a barometer of market positioning and sentiment, shows that traders are now again bearish on the euro after briefly turning to a positive outlook last week.
Although long positions in the euro swelled to their highest level since mid-2021 along with the currency’s recovery, some investors may be waiting for more evidence to support the argument to sell the dollar aggressively.
“You have to follow the trend, but by the same logic, selling the dollar after it has had a 6% move historically has not been a particularly profitable strategy,” said Francesca Fornasari, head of currency solutions at Insight Investment. “The dollar has probably peaked, but it’s not entirely clear that you’re going to see a big move down yet.”
–With help from Vasilis Karamanis.
(Updates with the ECB interest rate forecast in the third paragraph.)
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