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Risk/reward will be a key theme this week given uncertainty surrounding vital data releases and central bank meetings. Selling EUR/USD is tempting and still looks like an attractive long-term play. There is, however, still an important risk that the squeeze on long dollar positions has further to run. Overall, in this context, there look to be greater reward in selling EUR/AUD on technical, positioning and fundamental grounds with a realistic move to below 1.40.

The latest CFTC data continues to indicate net short positions in both the euro and Australian dollar for the latest week. The net euro position has, however, been cut to just over 30,000 contracts while the short Australian dollar position is still more than double this level and there is greater scope for further covering of short Australian positions.

The euro is trading near the top of its likely short-term trading ranges against the dollar, having already recovered from lows near 1.2750 to above 1.3250. The ECB looks unlikely to make any changes to interest rates at this week's policy meeting. There is, however, a small chance of action to expand monetary policy and there is no prospect of any tightening. The ECB is also likely to maintain dovish forward guidance with further hints of the possibility of negative deposit rates.

Central banks overall are likely to signal their determination to support growth through aggressive monetary policies and very low interest rates, which will help support the Australian dollar. The bloodletting in emerging markets has at least eased with a reduction in pace of capital outflows. This will provide some underlying Australian dollar support with the potential for limited carry-trade activity and a reversal in short-risk trades, especially with liquidity at seasonal lows.

The latest US Federal Reserve statement will be an extremely important focus on Wednesday. The most likely outcome is that policy will be left on hold and there will be no major deviation from June's statement. In essence, the Fed will repeat that it expects to start bond tapering this year if the economy performs as expected. A hawkish tone from the Fed would boost the US dollar and inevitably trigger a sharp euro decline. The Australian dollar would also fall, but at a slower pace, especially as there would be some optimism surrounding global growth, and EUR/AUD would be likely to weaken. If the Fed takes a dovish tone, the euro and Australian dollar are both likely to gain ground in tandem.

Chinese economic developments will continue to have an extremely important impact on the Australian dollar. There has been a substantial increase in concern surrounding the outlook, especially after the HSBC PMI index's decline to an 11-month low for July. There are certainly very good reasons to be fearful for Chinese prospects with the threat of an extremely serious credit crunch and a much more substantial deterioration in economic conditions on a 12-18-month horizon. This would also cause major damage to the Australian dollar. In the short term, however, there is a higher risk that the government and PBOC will "blink" and engage in stimulus measures to help underpin demand. This is liable to make the eventual adjustment even more severe, but there would be short-term optimism over Chinese and regional growth trends, which would support the Australian dollar, especially given the amount of negative potential already priced in.

The Reserve Bank of Australia (RBA) is not meeting until next week, limiting domestic activity. RBA Governor Stevens will speak this week on Tuesday local time and is likely to take a circumspect tone this time. Caution is likely after his comments last time around over the fact that the RBA took a long time in making the decision to leave interest rates on hold.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Source: 6 Reasons To Sell EUR/AUD This Week