From the perspective of fundamentals, U.S. rates are headed higher so the EUR/USD should be trending lower as the dollar appreciates. However better than expected economic data out of Germany and mixed U.S. data is making investors reluctant about selling the pair. Members of the European Central Bank may be talking about negative interest rates but with Germany growing at a faster pace, troubles in France and the periphery nations could fall to the wayside. In fact positive surprises out of Germany is one of the main reasons why ECB President Draghi is dismissing all talk of negative rates. There is no question that the ECB maintains a dovish monetary policy stance and in the past, when we have heard consistent dovishness from members of the Governing Council, it was their way of preparing the market for a move. However the EUR/USD has not budged this time around because without Draghi's endorsement, traders are skeptical about how serious the central bank really is about negative rates. Also, all of the ECB officials who have talked about negative rates simply described it as a policy option -- they did not say that it is needed. At the same time, U.S. tapering in 2014 is still more likely than 2013 and that has limited the sell-off in EUR/USD.
Also, the euro is the only realistic alternative reserve currency to the dollar and with the U.S. government expected to revisit the debt ceiling early next year, global reserve managers are starting to get tired of the U.S. fiscal fight. It is almost hard to believe that the battle in January/February will be the fourth in 2 years. The dollar will always represent an important share of reserves and the process for diversification will be gradual but right now the flows are supporting the currency. The following chart shows the recent correlation between theEUR/USD (gold line) and the price of German 10-year bonds (white line). Even with all of these fundamental factors in mind, however, the fact that the ECB is more dovish than the Fed means that the EUR/USD should be headed lower and we believe that it should only be a matter of time before the currency pair drops down to 1.32.
EUR/USD vs. Germany's 10-Year Bond
From the perspective of positioning, the latest IMM report from the CFTC showed the smallest amount of long EUR/USD positions since August. Speculators have been net long euros for the past 3 months but the following chart shows how the steep sell-off in the EUR/USD (gold line) between October 29 and November 7 was a liquidation of those positions (white line). Based on tight correlation seen in the following chart, the latest reduction in long positions should have driven theEUR/USD even lower. A new downtrend will require not only liquidation of the rest of the EUR/USD short positions but also initiation of fresh shorts.
Falling Long Positions
Unfortunately from a technical perspective, there is no clear direction for the EUR/USD. A head-and-shoulders pattern appears to be forming but the structure of the pattern is far from perfect. There are 2 levels of support near current prices - the 50% Fibonacci retracement of 2011-2012 sell-off and 1.3465, a level that was important in September and October. A break of 1.3465 would be required to open the downside for a move down to 1.32. On the upside, 1.650 would need to be broken to open the upside.
Head And Shoulders Pattern Forming
