EUR/USD, EUR/JPY forecast: Weak PMIs dampens euro as yen roars back

EUR/JPY forecast update: This morning saw the US dollar drop further against the Japanese yen and Swiss franc but gained ground against all other major currencies, with the euro falling for a second day following the release of rather disappointing eurozone PMI data. The yen is rallying as Japanese bond yields rise while yields in the US and Eurozone fall, with eyes on the Bank of Japan's upcoming meeting and speculations of a ten-basis point rate hike. While the yen continues to make a strong recovery following its big falls until earlier this month, the euro, however, is struggling, weakened by disappointing data. As a result, the EUR/JPY has been weakening, while the EUR/USD has also given up some of its recent gains.  Indeed, the latest PMI report delivers a blow to the ECB's hopes, revealing that the eurozone's economic recovery is faltering as both manufacturing and services sectors show signs of slowing. Optimism that had buoyed the eurozone at the beginning of the year is fading fast. Initial positive business sentiment and better-than-expected first-quarter GDP growth had sparked hopes for a robust recovery. However, recent data has dampened those expectations.

PMI data suggests Eurozone’s recovery is losing momentum

The July PMI composite index for the eurozone dropped to 50.1 from 50.8 in June, barely above the threshold that separates expansion from contraction. This drop signals a further weakening in economic activity as the third quarter begins. The manufacturing sector's PMI fell to 45.6, indicating persistent weakness, while services also slowed, with the PMI dipping to 51.9. To make matters worse, rising input costs continue to pose inflationary challenges.

On a country level, France saw a slight improvement in its PMI, although it still hovered below the 50-mark due to deteriorating manufacturing sentiment. Meanwhile, Germany's PMI readings fell sharply below 50, reflecting worsening sentiment in both manufacturing and services. After hosting the euros, a major sporting event, this hardly had any positive impact economic impact. France will be hoping for a better performance with the Olympics starting in Paris.

ECB President Christine Lagarde recently acknowledged that risks to the eurozone's growth outlook have shifted to the downside. While there are more indicators of growth than just PMIs, the latest readings highlight the sluggish pace of the eurozone's recovery, putting a negative bias on the EUR/JPY forecast.

Japanese yen strongest in FX

While the euro has struggled, the Japanese yen continues to roar back higher. The strengthening yen is a reflection of tightening of bond yield spread between Japan and the rest of the world, after ballooning following the years of excessive expansionary monetary policy in Japan while the rest of the world pursued a sharp contractionary policy to combat surging inflation. Now, those central banks are starting – or about to start – rate cuts, while Japan has only recently started to tighten its belt. As a result, Japanese yields continue to rise slowly while those of the rest of the world fall. Attention is now turning to the Bank of Japan meeting next week, and there is growing speculation that the central bank will raise interest rates by ten basis points. There is also the risk of further intervention from the Japanese government, although the recent recovery in the yen means there is less desire for them to do so. Meanwhile, the probably of another rate cut in the eurozone has increased following the softer PMI data.

EUR/USD drops as dollar trades mixed ahead of key US data

Meanwhile, the US dollar has weakened further against the yen and franc, but risen against everything else, including the euro. While the EUR/USD has weakened as a result, it could still benefit from the potential for the dollar to resume lower across the board. The market is now pricing in a 98% probability of a rate cut in September. The market will start to look beyond September and speculate about further rate cuts should upcoming US data this week disappoint expectations. We have US PMIs later today, followed by GDP on Thursday and Core PCE on Friday.

This week's headline story has been the US presidential race, which took a surprising turn with Joe Biden bowing out. This unexpected move has cast doubts over the future of the dollar and the trajectory of risk assets. The battle between Harris and Trump is anticipated to be tight, a factor likely to weigh on the dollar. The US dollar has weakened against the yen, but strengthened sharply against commodity dollars, amid the slump in crude oil and copper prices due to concerns about China’s economic health.

But the real influence on the dollar remains the Federal Reserve’s interest rate decisions. Investors are confident that the Fed will begin cutting rates in September, regardless of the election's outcome. I believe the greenback might start to decline once concerns about China subside, and as we shift our focus back to economic data heading into the latter part of the week. This should keep the downside limited for the EUR/USD.

EUR/JPY forecast: technical analysis

Source: TradingView.com

The sharp turn in the yen’s fortunes has caused popular yen pairs to break down key support levels, putting the EUR/JPY forecast in a bearish technical trajectory. The EUR/JPY has fallen a big 800+ pips from its July high of 175.42, which was the best level for decades.  This week alone, the EUR/JPY has shed some 450 pips, with the selling gathering pace after the bullish trend line going back to December was taken out. Undoubtedly, the breakdown triggered a bunch of stop orders that were presumably resting below that trend line. Interesting the breaking point of the trend line happened to be at around the same level as the high of 2008, ad just below the 170 handle. Given the historical importance of that level, we have seen the selling gather pace in the last two trading sessions.

Thus, moving forward, that 169.95-170.00 area will now be a major resistance zone to watch should we get a kick-back recovery in the next few days. Ahead of that level, interim resistances to watch will include the now broken June low of 167.52 and Tuesday’s low at 168.83.

In terms of potential support, the 38.2% Fibonacci retracement against the rally that commenced in December comes in at 166.92. Below that level, the next big level to watch is at 164.30, which marks the high from 2023 and the 50% retracement level. The fact that we have the 200-day average also residing in proximity of 164.00 handle, makes that area a significant support zone. But whether we will get there is another question.

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R