EUR/USD: Further Falls Cannot Be Excluded In The Near Term

EUR/USD: Further falls cannot be excluded in the near term
Macroeconomic overview:

• The USD retreat early in the past week proved very short-lived and in the end the greenback continued to strengthen. Since mid-April it has appreciated by more than 4% in trade-weighted terms. Importantly, this has happened despite IMM data on non-commercial commitments indicating that past extreme short positioning was heavily cut to around 63,350 net short contracts in the week ending on 11 May. This represents a two-thirds reduction since the peak of over 188,000 net short positions hit on 23 March.
• This evidence suggests that USD appreciation might gradually run out of steam going forward, but some caution has to be exercised at this juncture because:

1. previous excessive USD short exposure has been heavily cut but it still exists, which means the current short squeeze could have a bit further to run in the very near term;
2. US yields continue to climb, especially at the long end of the curve, with the 10Y maturity now well exceeding the 3% threshold and with also real yields accelerating;
3. there are still concerns about global economic growth, which could increase demand for the US dollar as a safe asset.

• That said, EUR/USD bulls have to be patient in the very near term, also because EMU PMI surveys for May, the most important data releases in the coming days, are expected to show another small decline, reflecting global economic uncertainty and the latest acceleration in oil prices.
• In our opinion the medium-term EUR/USD outlook for the rest of the year remains constructive. This is because:

1. overall, the Eurozone economy continues to hold up well;
2. markets now have a less impelling need to cover extreme short USD exposure;
3. more US curve-flattening, which historically is associated with a weaker US dollar, remains in the cards, as current yield levels in the US are probably too elevated given the current economic growth picture.

• What are major macroeconomic releases of the week? We expect Eurozone PMIs (Wednesday) to decline again in May, with the composite indicator down for the fourth consecutive month, to 54.8, a level consistent with annualized GDP growth of close to 2.5%. The Ifo Business Climate Index (Friday) is likely to decline further, albeit at a slower pace than in the previous months.
• Yesterday, the leaders of the Five Star Movement and the League, Luigi Di Maio and Matteo Salvini, seem to have reached a deal on a prime minister and they are likely to present the candidate and the coalition agreement to President Mattarella this afternoon. The president will then have to decide whether to give the designate-PM the mandate to form a government (probably tomorrow already) and immediately afterwards the designate-PM will start a short round of consultations with the two parties to define the list of ministers to be discussed with Mattarella. Should the president agree to the new cabinet, the government would then be sworn in before facing a vote of confidence in both houses of parliament.

Technical analysis and trading signals:

• EUR/USD's drop accelerated last week, registering the second biggest one-week fall of 2018, to perform a close below the 1.1790 Fibonacci level on Friday, 76.4% retrace of the 1.1555 to 1.2555 (November to February) gain. We will consider a short position on uptick to 1.1780.

GBP/USD: UK inflation remains on downward trend
Macroeconomic overview:

• We expect UK headline inflation (to be released on Wednesday) to have fallen by 0.1pp, to 2.4% yoy in April, and core inflation to have fallen by 0.2pp, to 2.1% yoy. The timing of Easter is likely to have been largely responsible for this; Easter this year fell at the start of April, as opposed to the middle of the month (which coincides with the ONS collection week) in 2017.
• The effect of the timing of Easter will likely mean that the prices of holiday-sensitive items, particularly air fares, created downward pressure. Partly offsetting this, motorfuel prices likely had an upward effect (contributing 0.1pp to headline inflation), both due to a positive base effect and the recent move higher in oil prices. In March, a large downward contribution came from clothing prices. This could have been reversed in April, as better weather led to spring clothing ranges being launched.
• When one looks through the noise created by the weather and the timing of Easter, inflation remains on a downward trend, as the upward effect from the past depreciation of sterling fades and more than offsets the recent rise in commodity prices.
• UK retail sales data will be released on Friday. We expect retail sales (excluding automotive fuel) to have fallen by 0.6% mom in April, in large part due to the timing of Easter but also due to further underlying weakness. This would follow a drop in March, when bad weather played a role.
• The Office for National Statistics will publish second estimate of first-quarter GDP data later this week. We expect GDP growth to be unrevised (0.1% qoq and 1.2% yoy). The risks are skewed towards an upward revision. Since the first estimate was published, industrial production was revised down 0.1pp, and construction was revised up 0.6pp, with a net effect of +0.02pp for GDP growth.

Technical analysis and trading signals:

• The GBP/USD broke from the daily doji range and the 200-day moving average is finally left behind. Former range base at 1.3452 provides initial resistance. The next GBP/USD bears target will be 1.3206 weekly cloud top.

Source: GrowthAces.com - daily forex trading strategies