EUR/USD pulls back towards 1.2250 after topping out just above 1.2300

• EUR/USD has been on the back foot in recent trade amid a deterioration in the market’s broader appetite for risk.
• EUR/USD has slipped back towards 1.2250 from previously above 1.2300.
• Markets are showing nerves ahead of risk events this week; the Georgia Senate election, US ISM PMI and NFP numbers and Fed minutes.

EUR/USD has slid back from previous highs to the north of the 1.2300 level amid a broad recovery from lows in the US dollar as risk appetite took a turn for the worse. 1.2310 seems to again provided tough resistance and EUR/USD now trades closer to 1.2250, but still clings on to fairly decent gains on the day of around 40 pips or over 0.3%. EUR/USD bears will be eyeing a move lower towards 31 December 2020 lows in the 1.2210s.

Downside in the pair in recent trade appears to be a function of a pickup in the US dollar from lows (the Dollar Index has recovered from the 89.40s to the 89.90s) amid a broader deterioration in risk appetite (major US equity bourses are now more than 2% lower on the day). Market participants appear to be taking some risk off the table ahead of key events later in the week (see below), as well as undergoing some volatility typical of this time of the year.

Factors to consider for EUR/USD this week…

Starting with the USD side of the equation; there are a few stand-out events for traders to keep an eye on.

1) Risk appetite – Early on during Monday’s session, numerous market commentators and analysts were pointing out that extreme risk on positioning (i.e. overweight stocks and other risk assets and underweight USD) presented a key downside risk to markets this week and going forward in 2021. In wake of the risk asset rally (particularly in stocks) seen since the start of November 2020 and expanded on during last week’s “Santa Rally”, some had even suggested that markets were entering the realm of “irrational exuberance”. Their warnings already appear relevant, with major US equity indices down more than 2% already on Monday amid a lack of any notable catalysts. If this pullback in sentiment continues later into the week and even month, this could support the US dollar.

Remember back to last September; from the beginning of August to the beginning of September, the Nasdaq 100 had rallied nearly 13%. However, by mid-September, the Nasdaq 100 had corrected nearly 15% from its earlier highs. If a similar move repeats itself, EUR/USD could be in for a ride.

2) US Data – Risks appear tilted to the downside for the USD with regards to how markets might interpret this week’s important ISM (released on Tuesday and Thursday) and official labour market data (released on Friday) for December. Market commentators have argued that good data might reinforce the risk on feel of the market, which has been a USD negative, while bad data might pump expectations for more monetary easing from the Fed, also a USD negative.

3) Georgia Runoff election – The two Senate seats up for grabs in Georgia will decide who gets control over the Senate (the Republicans or Democrats). While the election takes place on Tuesday, the outcome is likely to remain unknown for some time as mail-in ballots are counted. A similar reaction to the 3 November election is likely; Republicans are likely to have an early lead given stronger in-person voter turnout which will be counted faster, then the Democrats will catch up as the mail-in ballots are counted.

The Democrats need to win both seats to get a majority in Congress. The largest market reaction would be to an outcome where the Democrats manage to pull this off. In this case, expect significant further US fiscal stimulus in 2021 and higher nominal yields as a result. The USD is likely to be choppy as the outcome of the election remains uncertain, meaning EUR/USD is likely to be choppy too.

4) FOMC Minutes of the 15-16 December meeting – The Fed made a mild tweak to the forward guidance of its asset purchase programme, enough to reinforce expectations that it will continue to buy bonds at the current pace (or faster) until substantial progress has been made towards it inflation and unemployment mandates. The minutes ought also to reinforce market expectations that easy Fed monetary policy is going to stick around for a long time.

Turning quickly to the EUR side of the equation; while USD and global risk appetite dynamics, which will be influenced heavily by the above-mentioned factors, will play a crucial role in determining EUR/USD price action this week, some European factors are also worth bearing in mind.

Preliminary inflation data for December out of the likes of Germany, France, Spain and Italy will be released ahead of Eurozone aggregate numbers, which will be released on Thursday at 10:00GMT. Amid the worsening outlook for the Eurozone economy at the end of 2020 given lockdowns and Covid-19, no one is expecting anything aside from further downbeat inflation. Headline CPI likely stayed in deflation at a YoY rate for the sixth month running in December. This ought not have too much of a negative impact on EUR, given there is not much the ECB can or seems willing to do to materially change the near-term inflation outlook at this point. Indeed, if the EUR’s are actually appreciating in value in terms of their purchasing power (the definition of what deflation is!), all the more reason to hold them!

A speech from ECB Chief Economist Philip Lane at 20:45GMT on Monday will also be worth watching, as, of course, will any further development’s on the Covid-19/lockdown front on the continent.