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Can the Euro Breakout?

The U.S. Dollar is slipping a bit against the Euro overnight as the EUR USD continued to trade inside its almost 60 day range. Although it has been lingering at the top of the range, buyers have been reluctant to buy or sell heavily at this high level. The technical momentum hasn't been there either to drive it through the high for the year at 1.4337. Buyers have backed away on each approach because no one seems to want to print the high tick without solid evidence that the Euro Zone is clearly on the road to recovery.

The recent rally in the EUR USD has been driven by gains in the equity markets. Investors have been exiting the safer currencies during this time of stock market expansion. This week's gains have for the most part been limited by the choppy action in equities, thus preventing the Euro from surging to the upside. The selling pressure that hits the Euro each time the market approaches the 60-day high could be an indication that equity markets are getting close to a top.

Fed Chairman Bernanke's comments this week regarding inflation have also put a lid on the Euro. In his testimony before the Senate Banking Committee, Bernanke said that the Fed has the tools to keep inflation at bay. On the other hand, Bernanke provided a little fuel for a Euro rally by stating that the economy's recovery will be gradual because of rising unemployment.

The key to a prolonged rally in the EUR USD will be the direction of interest rates. While Bernanke said the Fed would gradually raise rates after it begins to implement its exit strategy, he did emphasize that it is difficult to pinpoint a time for the move. There are some media analysts who believe we are months - or perhaps years - from a substantial interest rate hike. Based on this scenario, the Euro should maintain its strength versus the Dollar as long as the European Central Bank doesn't surprise the market by cutting interest rates.

The real fear for the Dollar bulls should be whether the ECB will raise rates before the Fed does because the ECB tends to see inflation when and where it wants to find it. In addition, the ECB is also pretty quick on the trigger finger when it comes to raising rates. The ECB meets again on August 6th. If the EUR USD is still trading inside of the current trading range then a surprise rate hike is exactly the kind of event that will trigger a breakout to the upside.

All you have to do is remember July 2008 - the last time the ECB hiked its benchmark rate. It was the last major central bank to do so while all others were in the midst of a series of cuts.

Barring a substantial break in the stock market, the EUR USD is expected to maintain its upside bias as demand for higher risk assets grows. If this pair remains inside of its current range then it may take a surprise interest rate hike to trigger a Euro surge to the upside. Traders should also note that even talk of an interest rate hike could fuel an upside breakout as speculators will buy with both hands.

 

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