The market has been shaken by strong risk aversion this week which propelled USD and JPY rallies as safe-havens currencies. The euro was particularly weighed by Bundesbank's Weidmann discussing quite openly the option of an ECB rate cut, which could be a signal that the German economy might worsen.
Such comments saw the euro lost 2 big figures from 1.3200 to 1.3000 on Wednesday and even though EUR/USD trimmed losses on Thursday, the pair could remain vulnerable in the wake of Italian elections amid other lingering woes in the eurozone.
"Yesterday's comments from the Bundesbank's Weidmann-suggesting his openness to rate cuts if Eurozone data deteriorates further-did considerable damage to the EUR's constructive move since the beginning on April", says TD Securities team. "The positive risk mood has helped buoy the EUR overnight, but we would need to see a sharp move higher to reinvigorate bullish momentum".
On the other hand, the U.S. economy seems in better shape, as shown by latest indicators and confirmed by yesterday's Beige Book. The dollar should benefit from the economic recovery as the Fed refrains from adding stimulus and even debates the possibility of exiting easing measures.
According to David Song, analyst at DailyFX, the Fed will retain its asset purchase program at $85/month in an effort to encourage a stronger recovery, "but the resilience in private sector consumption along with the budding recovery in the housing market may prompt a growing number of central bank officials to scale back their willingness to expand the balance sheet further as the region gets on a more sustainable path".
In Song's view, the shift in the policy outlook should prop up the U.S. dollar over the near to medium-term as we may see the FOMC start to discuss a tentative exit strategy in the second-half of the year as growth prospects improve.
Technically speaking, EUR/USD failure to break above the 1.3200 level deteriorated EUR/USD outlook, although daily charts hold a slight positive tone. However, a break below 1.3000 could encourage sellers and might push the cross toward the 200-day SMA around 1.2965. On the other hand, a break above 1.3100 is needed to improve the picture, but only sustained gains above the 1.3200/30 area (50% retracement of the 1.3710/1.2750 drop) would strengthen the positive bias.