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Euro's rollercoaster: Decline, rebound expectations, and market emotions

Euro's rollercoaster

The euro has experienced a significant decline recently, marking an impressive series of drops. Initially, investors were faced with an interest rate cut by the European Central Bank (ECB). This move by the ECB was designed to stimulate the economy by making borrowing cheaper, which in turn should encourage spending and investment. However, such a reduction in interest rates typically makes a currency less attractive to investors, leading to a depreciation of the currency. This is precisely what happened with the euro.

Following this, market sentiment further deteriorated due to the European Parliament elections. These elections often bring about uncertainty as investors and market participants anticipate potential shifts in policy and political stability. However, despite these challenges, experts in the financial markets believe that the sell-off of the EUR/USD pair was exaggerated. This means that the reaction of the market to these events was more severe than justified by the actual economic fundamentals. As a result, these experts expect a strong rebound of the euro.

They predict that after the second round of the French parliamentary elections on July 6, the euro could climb back to around 1.08 against the US dollar. This prediction is based on the assumption that the market will stabilize and regain confidence once the political uncertainty in France is resolved.

The situation surrounding the euro remains complex and multifaceted. Market expectations regarding interest rate cuts are volatile, changing from week to week. This volatility is driven by a combination of economic data releases and shifting investor sentiment. Furthermore, economic data is being interpreted selectively by the markets. This selective interpretation means that investors might focus on certain data points while ignoring others, depending on the prevailing sentiment and expectations.

In our view, it is the emotional responses of investors, rather than fundamental economic factors, that are currently driving the major currency pairs. This can lead to exaggerated market movements, as seen in the recent sell-off of the euro. For the EUR/USD pair, there are several potentially bearish scenarios on the horizon. One such scenario is a higher-than-expected reading of the Personal Consumption Expenditures (PCE) index, which is due to be released on Friday.

A higher PCE reading would indicate stronger inflationary pressures in the US, which could prompt the Federal Reserve to consider raising interest rates. This, in turn, would strengthen the US dollar against the euro. Another bearish scenario could be a strong result for the far-right in the French elections, which could heighten political risks within the eurozone.

Analysts emphasize the significant role that emotions play in the markets, particularly in times of growing problems and geopolitical tensions. The financial markets are highly sensitive to news and events that can trigger emotional responses from investors. These emotional responses often lead to increased volatility and exaggerated market movements. For instance, geopolitical tensions, such as conflicts or trade disputes, can create uncertainty and fear, leading to risk-averse behavior among investors. This can result in sharp movements in currency pairs, as seen with the euro recently.

The issues within the eurozone are quite evident and remain a significant concern for investors. Economic challenges, such as sluggish growth and high unemployment rates in some member countries, contribute to a negative outlook for the euro. On the other hand, the US economy appears more resilient to high interest rates. Despite the Federal Reserve’s monetary tightening, the US economy continues to show signs of strength, surprising many with its robust performance.

This resilience makes the US dollar more attractive to investors compared to the euro. However, after the second round of the French parliamentary elections, we anticipate a shift in market sentiment. We expect the market to enter a phase of optimism, driven by the resolution of political uncertainty in France. In this optimistic scenario, the EUR/USD pair could potentially target the resistance level of 1.0760, as investors regain confidence in the euro.

Currently, the market is contending with a short-term downtrend line at 1.07. This means that the euro is facing resistance at this level, and any attempts to move higher are being met with selling pressure. Despite this, the euro remains relatively strong. This resilience is noteworthy, especially given the recent discouraging PMI readings for the eurozone and the disappointing Ifo data from Germany. PMI readings are important indicators of economic activity, and weak numbers suggest a slowing economy.

Similarly, the Ifo Business Climate Index is a key indicator of economic sentiment in Germany, and weak readings indicate a pessimistic outlook among businesses. Despite these challenges, the euro has managed to hold itsground, which suggests underlying strength. It appears that the market is attempting to offset the negative impact of the French elections. Investors are beginning to consider the long-term implications of these elections and how they might affect political risk in the eurozone. If the outcome of the elections reduces political risk, it could lead to a more stable and positive outlook for the euro in the long run.

eurusd analysis
EUR/USD daily chart, MetaTrader. 26.06.2024

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