EUR/USD signal for July: bears to remain in control

As summer trading conditions affect financial markets, the week ahead may be different because volatility may rise. Despite Friday being the first trading day of the new month, the Non-Farm Payrolls release is postponed for one more week.

But traders do have plenty of market price action to watch and interpret, as the ECB Forum on Central Banking starts tomorrow. Policymakers from the world’s central banks meet in Sintra, Portugal, to discuss the response to rising inflation and the challenges posed to monetary policies by the war in Ukraine and lockdowns in China.

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Naturally, the volatility of the euro pairs will be higher than usual. Out of all the euro pairs, one, in particular, is under severe pressure.

And that is the EUR/USD.

Technical analysis suggests more downside is possible

The EUR/USD exchange rate sits at a critical level. While it has found buyers below 1.05, it failed to rally significantly.

As such, the pressure mounts for the currency pair to threaten a move towards the parity level. A currency pair reflects the value of one currency in terms of another, and when it reaches parity, the two currencies are equal.

The last time the exchange rate crossed parity was in 2002. Then, the common currency rallied to 1.30 before correcting a bit, and then extended the rally to 1.60.

But the 2008-2009 Great Financial Crisis was too much for the EUR/USD. Scared, investors looked for the safety of the world’s reserve currency.

So they sold the euro and bought the US dollar.

After several years, the ECB adopted a dovish policy under Mario Draghi’s leadership. It lasted for more than 8 years, and Draghi went down as the ECB President to never hike the interest rate.

So the EUR/USD exchange rate declined and was sold on every rally. Since 2008, it has kept forming lower highs.

Moreover, now it puts pressure on horizontal resistance after being sold at 1.20 – a confluence area where both dynamic and horizontal resistance attracted sellers.

At this point in time, the failure of a significant bounce brings into discussion another possible bearish pattern that might complement the lower highs series. That is, a descending triangle.  

How about fundamental analysis?

Fundamental analysis also points to further declines for at least three reasons. First, the interest rate differential between the Fed and the ECB will continue to rise in the months ahead.

Second, rising energy prices due to the conflict in Ukraine harm the Euro area economy and thus, weigh on the common currency too.

Finally, the exchange rate failed to react to the increasing hawkish signals from the ECB. The central bank announced rate hikes to come this year, as soon as July, but the EUR/USD barely moved.

Moreover, a new antifragmentation tool designed to deal with rising spreads on periphery bonds failed to prop the euro. Again, the EUR/USD barely reacted.

But other euro pairs did move to the upside. EUR/GBP is well off its lows, and EUR/JPY is in a strong bullish trend.

Hence, it appears it is all about the US dollar’s strength and the Fed’s policy, which is much tighter than the one the ECB plans for the months ahead. Therefore, a EUR/USD move below parity should not surprise anyone.