EUR/USD: Picking Up The Pieces After Yellen

Tuesday’s decline confirmed a few bearish developments for this pair, firstly, EUR/USD closed below 1.3584 – the 61.8% retracement of the recovery from June 12 to July 1st. This caused the MACD to settle below its zero line, which suggests that momentum is now to the downside.

EURUSD’s bearish technical picture was given a nudge by Janet Yellen, the chairwoman of the Federal Reserve, on Tuesday when she delivered her semi-annual testimony to the Senate. She delivers the same message to the House at 1500 BST/ 1000 ET today.

The dollar responded positively to Yellen’s comments, while she sounded cautious about the economic outlook and said that monetary stimulus is still required, she let slip that rates could rise sooner than expected if jobs and inflation rise faster than currently forecast.

On top of the weak technical picture, the perfect storm could be brewing for the EUR; a couple of things threaten its medium-term performance:

h3 1. A stronger dollar:/h3

If we continue to see solid jobs growth and a less dovish tone from the Federal Reserve then we could see resurgence in the dollar. The technical picture is bright.

Firstly, the dollar index closed above its 200-day sma on Tuesday and continues to advance today. Secondly, the 2-year Treasury yield remains elevated and close to its highest level in 12 months.

The German 2-year – U.S. 2-Year yield spread is at its lowest level since 2007, and the spread has diverged from EURUSD. Since this yield spread tends to have a positive historical relationship with EURUSD, this pair may play catch up with the yield. (See figure 1).

h3 2. Banking sector woes for Portugal:/h3

Last week, problems at Portugal’s largest lender, Banco Espirito Santo (LISBON:BES), spooked the markets and peripheral bond yields surged. This week, things have calmed down and yields have retreated, however, problems with BES remain.

On Wednesday, the extent of BES’s problems was revealed after a deal between Portugal Telecom and Oi, a Brazilian Telecoms company, was called into question by a default of one of the investment units in the Espirito Santo group. The problem is not actually BES itself, rather defaults within the investment unit of the Holding Company; however, BES may be forced to bail out these troubled units.

If BES can’t cope then we could see it tap the sovereign vein, which could trigger another round of sovereign debt fears. While this incident may be manageable, if it spreads elsewhere then the toxic link between banks and sovereigns could come back to haunt the market.

h3 So where could EURUSD go now?/h3

We said yesterday that a break below 1.3585 would shift our focus to the next key support level at 1.3477- the February low. Below here opens the door to 1.3248 – the 38.2% retracement of the July 2012 – March 2014 bull trade, and a key level of support in the medium-term. With momentum turning lower, we think that it could be rocky road for EURUSD for the rest of this summer.

h3 Takeaway:/h3

• • The technical picture is looking bleak for EURUSD.
• • Yellen’s testimony has boosted the dollar, and there is a chance that the greenback may have turned a corner.
• • The yield spread between 2-year German and US bond yields suggests that there could be further downside for EURUSD.
• • Sovereign debt fears continue to linger as Portugal’s BES saga continues.
• • A break below 1.3477 may cause the market to focus on 1.3248 – a key Fib support level.

Figure 1:

Source: FOREX.com and Bloomberg

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Written By: FOREX.com