Euro Rallies On Spain Optimism: Too Early To Call A Bottom?

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Includes: DRR, ERO, EUFX, EUO, FXE, ULE, URR
by: FXstreet

The euro rallied versus the dollar and overtook the 1.3000 handle on Tuesday propelled by more supportive comments about Greece, news reports suggesting that Spain is preparing to make the rescue request, and a mixed German ZEW survey.

However, the stronger EUR/USD move came after a report said that German lawmakers are open to Spain seeking a precautionary credit line from Europe's rescue fund, indicating a rolling back of German resistance to a full sovereign bailout for Spain.

Stocks in Europe and the US were also supported by the positive market mood and by some strong earnings reports in pre-market trading. In the macroeconomic domain, US consumer price index rose mainly in line with expectations but remained at non-threatening levels. However, as the Fed has stated that inflation is not a concern right now, with today's figures backing that idea, the impact on the market was minimized.

Euro nears key resistance, short-term outlook improves

EUR/USD rallied to a high of 1.3059 driven by the decreased uncertainty over financial markets, although the single currency remained well within its recent tight range roughly between 1.3170 and 1.2800. EUR/USD was last up 0.8% at the 1.3050 zone.

Could the euro sustain gains? Well, on the absence of any real developments out of Europe, the EUR/USD will likely remain rangebound in the short-term, with the summit of EU leaders in focus. That said, euro's short-term outlook has turned more bullish after overcoming the 1.3000 hurdle.

In the medium term, the technical picture would improve if the EUR/USD manages to break above the early October high at the 1.3070 area, which will open way towards key resistance at 1.3170, 9/14 and 9/17 double top and confirm double bottom at the 1.2800/20 zone. However, near-term overbought readings suggest corrective action would precede fresh strength.

"While we don't view today's FX moves as decisive, market participants are seemingly inclined towards optimism rather than pessimism at this point, and remain sensitive to European headlines", says the Wells Fargo team. "We have a slight bias toward strength in the euro and other foreign currencies, so long as the headlines suggest that further financial assistance for Greece and Spain remains a possibility".

However, it may be too early to call a bottom at 1.2800 as downside risks will persist as long as Rajoy continues to play hard to get while eurozone's problems are far from over. Moreover, Moody's decision on Spain's rating is still looming, even though a reaction to a downgrade would be at this point questionable. On one hand, it would be a negative signal for country as it could be the first of the major agencies to put Spain below the investment grade; however, as seen with the S&P downgrade, the euro rose on the idea that the country would be closer to request aid.

In this regard, Jane Foley, analyst at Rabobank, acknowledges that Spain remains in centre stage and argues "that an increase in tension in Spain could force pullbacks in EUR/USD, we now expect these to be limited to the EUR/USD1.2800 area on a 1 month view, with EUR/USD potentially remaining essentially range driven into year-end".

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