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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.
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EUR/USD, GBP/USD vulnerable as Powell delivers technical damage

Article By: ,  Market Analyst
October 1, 2024 2:04 AM
  • EUR/USD and GBP/USD trade as proxies for the global economic outlook
  • Markets remain priced for another large Fed rate cuts in 2024
  • Further softening in US labour market indicators necessary to justify rates outlook
  • EUR/USD, GBP/USD rallies stall ahead of key US economic data

Proxies for global economic outlook

EUR/USD and GBP/USD continue to trade as proxies for the global economic outlook, benefitting not only from expectations the US Federal Reserve will cut rates to neutral levels over the next 15 months, but also optimism the easing cycle will not be accompanied by a damaging downturn in activity.

You can see that in the correlation analysis below with strong positive relationships with stock and commodity futures over the past month. As they’ve risen, it’s benefitted the euro and pound. Both have also been highly correlated with movements in the Chinese yuan against the greenback, another cyclical variable.

The positive correlation with the US2s10s US Treasury curve has also strengthened, implying the prospect of an expected pickup in growth and inflation in the future in the world’s largest economy is providing tailwinds, as is the gradual increase in the magnitude of expected Fed rate cuts this year.

As the shape of the Fed funds futures curve between September and December has become more negative, shown in the chart below, EUR/USD and GBP/USD have often moved in the opposite direction. When looking at variables to track as part of the analysis, those linked to the outlook for European and British interest rates were weak to non-existent.

Soft landing likely needed to unlock upside

The overriding message from the correlation analysis suggests EUR/USD and GBP/USD are benefitting from an environment where large-scale Fed rate cuts are priced, but a major economic downturn is not.

However, were that to change due to a large increase in rate cut pricing due to deterioration in economic conditions, or stronger economic activity negating the need for the Fed to ease aggressively, it may generate renewed headwinds for EUR/USD and GBP/USD.

That means traders need to be on alert for events that could materially change the outlook for US interest rates, rather than those that could shift rate cut pricing from the ECB or Bank of England.

Event risk picking up

The calendar of events deemed high risk is shown below for the US, UK and euro area over the remainder of the week. While there’s always a chance the Eurozone inflation data could surprise in either direction, with figures already out from major European nations beforehand, the risk of such an outcome does not come across as meaningful.

Instead, it will be non-farm payrolls from the US on Friday, and ISM manufacturing and services PMIs on Tuesday and Thursday respectively, that could really shake things up depending on the message they reveal when it comes to the health of the US labour market. I’d also throw in the ADP National Employment report on Wednesday and weekly jobless claims data on Thursday as other events that could generate meaningful volatility depending on the detail.

EUR/USD drops through rising wedge

On the back of a modest pushback from US Fed chair Jerome Powell on Monday against the recent increase in US rate cut wagers, EUR/USD has broken out of the rising wedge pattern it had been trading in since early September.

EUR/USD struggled above 1.1180 in recent weeks, constantly trying to break to new highs before reversing. With US rate cut pricing looking rich relative to the strength of incoming US economic data, and with RSI (14) and MACD providing bearish signals on price momentum, selling rallies is now arguably the better strategy.

Should EUR/USD reverse towards former wedge support, you could sell with a stop above 1.1214 for protection. To make the trade work from a risk-reward perspective, you’d have to see the price break support located around 1.1075, bringing a potential flush towards 1.1045 and the 50-day moving average into play.

The other option would be to sell around these levels with a tight stop above targeting the same downside targets, although this screen as a lower probability play.

GBP/USD uptrend stalls

GBP/USD is also looking vulnerable after delivering a gravestone doji on Monday, breaking out of the ascending channel it’s been trading in since early September after stalling at resistance located at 1.3433. The With RSI (14) breaking its uptrend, momentum also looks to be turning even if the signal has not yet been confirmed by MACD.

You could sell around these levels or wait for a potential push higher, allowing for a stop to be placed above 1.3433 for protection. Downside targets include 1.3265 and 1.31400.

-- Written by David Scutt

Follow David on Twitter @scutty

 

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