EUR/USD Still Susceptible to Larger Pullback as RSI Divergence Remains

EUR/USD Rate Talking Points

EUR/USD struggles to preserve the advance following the European Central Bank’s (ECB) first meeting for 2021 as the US Dollar appreciates on the back of waning investor confidence, and the exchange rate remains susceptible to a larger pullback as long as the Relative Strength Index (RSI) tracks the downward trend carried over from December.

EUR/USD Still Susceptible to Larger Pullback as RSI Divergence Remains

EUR/USD continues to hold above the 50-Day SMA (1.2103) as the ECB retains the current course for monetary policy, and it seems as though the Governing Council will rely on its current tools to support the Euro Area as the central bank pledges to carry out the EUR 1.850 trillion pandemic emergency purchase programme (PEPP) “until at least the end of March 2022 and, in any case, until the Governing Council judges that the coronavirus crisis phase is over.”

Nevertheless, it seems as though the ECB will continue to endorse a dovish forward guidance in 2021 as President Christine Lagarde and Co. “stand ready to adjust all of our instruments, as appropriate, to ensure that inflation moves towards our aim in a sustained manner,” and current market themes may keep EUR/USD afloat as the Federal Reserve’s balance sheet climbs to a fresh record high in January.

In turn, the pullback from the monthly high (1.2350) may turn out to be an exhaustion in the bullish price action rather than a change in trend like the behavior seen in late 2020, and the US Dollar may continue to reflect an inverse relationship with investor confidence as long as the Federal Open Market Committee (FOMC) remains on track to increase its “holdings of Treasury securities by at least $80 billion per month and of agency mortgage-backed securities by at least $40 billion per month.”

At the same time, the tilt in retail sentiment looks poised to persist going into the FOMC interest rate decision on January 27 as traders have been net-short EUR/USD since November, with the IG Client Sentiment report currently showing 41.60% of traders net-long the pair as the ratio of traders short to long stands at 1.40 to 1.

The number of traders net-long is 18.20% higher than yesterday and 11.74% lower from last week, while the number of traders net-short is 4.26% higher than yesterday and 5.34% higher from last week. The decline in net-long position comes as EUR/USD struggles to retain the advance following the ECB meeting, while the rise in net-short interest has fueled the crowding behavior as 44.25% of traders were net-long the pair last week.

With that said, key market themes may sway EUR/USD going into the Fed rate decision as the US Dollar still reflects an inverse relationship with investor confidence, but the exchange rate remains susceptible to a larger correction as long as the Relative Strength Index (RSI) tracks the downward trend established in December.

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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) highlighting a similar dynamic as it broke out of the downward trend carried over from the end of July to recover from its lowest readings since March.
• The break/close above the 1.1960 (38.2% retracement) to 1.1970 (23.6% expansion) region pushed EUR/USD to a fresh yearly highs throughout December, with the exchange rate taking out the 2020 high (1.2310) during the first week of January.
• However, EUR/USD has snapped the monthly opening range following the failed attempt to test the April 2018 high (1.2414), with the exchange rate still susceptible to a larger pullback as the RSI continues to track the downward trend established in December.
• Failure to hold above the Fibonacci overlap around 1.2140 (50% retracement) to 1.2370 (61.8% expansion) may push EUR/USD back below the 50-Day SMA (1.2081) as it brings the 1.2080 (78.6% retracement) region back on the radar, with the next region of interest coming in around 1.2010 (100% expansion).

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— Written by David Song, Currency Strategist

Follow me on Twitter at @DavidJSong