Euro Forecast: EUR/USD Outlook Clouded by RSI Divergence

EUR/USD Rate Talking Points

EUR/USD trades to a fresh monthly low (1.1704) as it snaps the range bound price action carried over from late last week, but the Relative Strength Index (RSI) appears to be diverging with price as the weakness in the exchange rate fails to push the indicator into oversold territory.

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EUR/USD Rate Outlook Clouded by RSI Divergence

Recent price action indicates a further decline in EUR/USD as it extends the series of lower highs and lows from the start of the week, but fresh updates coming out of the European Central Bank (ECB) appear to be shoring up the Euro as the central bank scales back the pace of the pandemic emergency purchase programme (PEPP) for the first time since the consolidated financial statement for February 26.

Image of ECB balance sheet

Source: ECB

EUR/USD attempts to retrace the decline from earlier this week as the PEPP widens EUR 20.4 billion in the week ending March 26 after expanding EUR 21.9 billion the week prior, and it remains to be seen if the pace of asset purchases have reached its peak as the update to the Euro Area Consumer Price Index (CPI) shows the headline reading widened to 1.3% from 0.9% in February.

However, the ECB may continue to endorse a dovish forward guidance as the Economic Bulletin for March underscores an adjustment in the weighing for the Harmonised Index of Consumer Prices (HICP), and the Governing Council may retain the current course for monetary policy at its next interest rate decision on April 22 as President Christine Lagardewarns of a technical recession.

Until then, the Euro stands at risk of facing headwinds if the ECB ramps up the pace of the PEPP, and the decline from the January high (1.2350) may turn out to be a change in EUR/USD behavior rather than a correction in the broader trend as the depreciation in the exchange rate spurs a shift in retail sentiment, with traders flipping net-longfor the fifth time in 2021.

Image of IG Client Sentiment for EUR/USD rate

The IG Client Sentiment report shows 56.39% of traders are currently net-long EUR/USD, with the ratio of traders long to short standing at 1.29 to 1.

The number of traders net-long is 8.11% higher than yesterday and 5.51% higher from last week, while the number of traders net-short is 4.06% higher than yesterday and 3.98% lower from last week. The rise in net-long interest has done little to alleviate the shift in retail sentiment as 54.83% of traders were net-long EUR/USD earlier this week, while the decline in net-short interest could be a function of profit taking behavior as the exchange rate attempts to bounce back from a fresh monthly low (1.1704).

With that said, the decline from the January high (1.2350) may turn out to be a change in EUR/USD behavior rather than a correction in the broader trend as the exchange rate trades below the 200-Day SMA (1.1865) for the first time since May 2020, but the Relative Strength Index (RSI) appears to be diverging with price as the weakness in the exchange rate fails to push the indicator into oversold territory.

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EUR/USD Rate Daily Chart

Image of EUR/USD rate daily chart

Source: Trading View

  • Keep in mind, the EUR/USDcorrection from the September high (1.2011) proved to be an exhaustion in the bullish price action rather than a change in trend following the string of failed attempts to close below the 1.1600 (61.8% expansion) to 1.1640 (23.6% expansion) region, with the Relative Strength Index (RSI) reflecting a similar dynamic as the oscillator broke out of the downward trend to recover from its lowest readings since March.
  • However, EUR/USD has reversed course following the failed attempt to test the April 2018 high (1.2414), with the exchange rate extending the decline from the January high (1.2350) to trade below the 200-Day SMA (1.1865) for the first time since May 2020.
  • In turn, EUR/USD may continue to track the descending channel from earlier this year as the 50-Day SMA (1.2010) reflects a negative slope, with the RSI highlighting a similar dynamic as it retains the downward trend established at the start of 2021.
  • The recent series of lower highs and lows has pushed EUR/USD up against the Fibonacci overlap around 1.1700 (23.6% expansion) to 1.1710 (61.8% retracement), with the next area of interest coming in around 1.1660 (38.2% expansion) to 1.1680 (50% retracement).
  • Will keep a close eye on the RSI appears to be diverging with price as indicator fails to push into oversold territory, and the oscillator may show the bearish momentum abating if it threatens the downward trend from earlier this year.

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— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong

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