US Dollar’s Path Tied to Inflation Outlook; Setups on EUR/USD, USD/JPY, GBP/USD

Trading often tempts us to follow the herd – buying when everyone else is buying, and selling in a frenzy of fear. But savvy traders understand the potential hidden in contrarian strategies. Indicators like IG client sentiment offer a unique window into the market's collective mood, revealing instances where overwhelming optimism or pessimism can signal a potential reversal.

Of course, contrarian signals aren't a crystal ball. They shine brightest when used to enrich an already robust trading strategy. By combining contrarian insights with careful technical and fundamental analysis, traders gain a richer understanding of the forces driving the market – forces that the crowd might easily overlook. Let's explore this concept by examining IG client sentiment and its potential impact on the euro across four key FX pairs: EUR/USD, EUR/CHF, EUR/GBP, and EUR/JPY.

IG data reveals a slight but fading bullish bias towards the EUR/USD among retail traders. Currently, 53.15% of clients hold net-long positions, resulting in a long-to-short ratio of 1.13 to 1. This positive tilt has weakened significantly, with net-long positions down a substantial 10.90% compared to yesterday, despite a tiny 0.05% increase over the week. Mirroring this, net-short positions surged by 31.26% since yesterday and are up 11.10% over the week.

Typically, a net-long stance hints at potential declines from a contrarian perspective. But, the recent shift in sentiment complicates the outlook. While a slight majority still favors the upside, the growing number of traders leaning bearish could signal an impending bullish burst for EUR/USD.

All in all, EUR/USD presents a mixed picture. It's essential for traders to proceed with caution and not rely solely on sentiment. These insights should be combined with thorough technical and fundamental analysis for a well-informed trading strategy.

EUR/CHF FORECAST – MARKET SENTIMENT

Data from IG reveals clients are bullish on EUR/CHF, with 53.08% of traders currently holding net-long positions. This results in a long-to-short ratio of 1.13 to 1. However, sentiment appears to be weakening, with net-long positions down 3.10% since yesterday, even while they've increased by 8.70% compared to last week. Mirroring this, net-short positions are up 12.18% from yesterday but down 6.75% compared to last week.

Our typical contrarian approach suggests EUR/CHR could be in for a pullback. However, the recent weakening of buying positions on the pair and the mixed timeframe comparisons create a less confident outlook.

Overall, the EUR/CHF presents a complex picture based on current sentiment. While there may be some downward pressure, the lack of a strong contrarian signal warrants caution. As always, traders should consider these clues within a broader technical and fundamental analysis framework before making any trading decisions.

EUR/GBP FORECAST – MARKET SENTIMENT

Based on IG data, the sentiment surrounding EUR/GBP within the retail crowd appears optimistic, with 61.22% of traders maintaining net-long positions. This equates to a long-to-short ratio of 1.58 to 1. Nevertheless, this bullish stance is beginning to wane, as net-longs have declined by 1.80% since yesterday, despite a 4.95% jump over the past week. In contrast, net-shorts experienced a large 9.01% surge from yesterday but demonstrate a more consistent decrease of 12.00% versus last week’s levels.

Traditionally, substantial net-long positioning might indicate potential losses for the underlying asset from a contrarian standpoint. However, recent shifts in market positioning have clouded the clarity of this signal. Presently, EUR/GBP appears to be caught amidst conflicting forces. While contrarian indicators still suggest some downward pressure is probable, the absence of a robust, enduring trend renders it a less assured prediction.

EUR/JPY FORECAST – MARKET SENTIMENT

IG data reveals a strong bearish bias towards the EUR/JPY, with 73.47% of traders currently holding net-short positions. This translates to a significant 2.77 to 1 short-to-long ratio. Notably, the number of net-short positions has climbed by 7.11% since yesterday and 1.73% compared to last week. However, net-long positions have also surged, up 25.13% from yesterday and a notable 18.78% from last week.

Our contrarian approach suggests this heavy net-short positioning could be a positive sign for the EUR/JPY. Yet, the recent weakening of the bearish bias introduces a degree of uncertainty. While the contrarian perspective still points to potential gains for the pair, the increasing number of long positions over key timeframes warns that a trend shift may be imminent.

As always, traders should carefully integrate sentiment signals with a well-rounded strategy that includes thorough technical and fundamental analysis.

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• USD/JPY continued to sideways range trade, with bullish fundamentals offset by the threat of BOJ intervention
• US CPI and PPI reports, the ECB interest rate decision and geopolitics loom as the key drivers for USD/JPY this week
• Near-term bias remains to sell rallies in USD/JPY rather than buying dips

The overview

USD/JPY sits in a narrow trading range, sandwiched by bullish fundamentals and threat of intervention from the Bank of Japan to support the yen. The latter has reduced the odds of near-term upside for USD/JPY despite the release of important inflation updates in the United States this week.

Unless the Japanese government softens its public stance towards weakness in the yen, the preference is to sell rallies rather than buy dips or breaks. Geopolitical tensions in the Middle East are another wildcard for traders to navigate.

Key events for USD/JPY

There’s no need to reinvent the wheel when it comes to the likely USD/JPY drivers this week with the US interest rate outlook and geopolitics the key areas to focus on. As the latter is impossible to predict, what we as traders can do is look at the events that are likely to have the largest impact, taking into consideration positioning and technical factors.

Over the week, three such events stand out: the US consumer price inflation report on Wednesday, the US Producer price inflation report on Thursday and the ECB interest rate decision, also on Thursday. While the Fed speaking calendar is extremely busy, they key point to remember is the tone will be heavily influenced by these events, along with last Friday’s blockbuster US non-farm payrolls report.

There’ll be plenty of headlines to navigate, including from the FOMC minutes on Wednesday, but the vast majority will be noise and not impact USD/JPY meaningfully.

US CPI preview

Having topped market expectations at the headline and underlying level in the first two months of the year, markets may receive greater clarity as to whether the inflation acceleration is the start of a new trend or simply a seasonal anomaly.

Both headline and core CPI are forecast to lift 0.3%, down a tenth from February. While a deceleration, both would be incompatible with inflation returning to the Fed’s 2% inflation mandate in a timely manner.

The core services ex-housing figure, known simply as “supercore” inflation, will be influential given the Fed has nominated it as something it’s watching. It decelerated noticeably in February, minimising the damage to the dovish rates case despite the heat in other readings.

Potential USD/JPY market reactions

If that happens and we see no upside surprise in the core or headline inflation rates, it’s likely US front-end bond yields will decline, dragging back-end rates lower with it. That should narrow the yield differential between the US and Japan and weigh on USD/JPY. However, if we see another upside surprise, especially at the core level, USD/JPY and yields would likely lift, reflecting the diminishing case for Fed rate cuts in 2024.

Source: Refinitiv 

US PPI, ECB rates decision in focus

The same approach applies for Thursday’s producer price inflation report with a hotter reading likely to lift USD/JPY, and vice versus if cold. A 0.3% gain is expected.

The ECB monetary policy meeting is the other key event simply because the euro is the largest weight in the US dollar index, making its fluctuations influential on other G10 FX names, including the yen. While no change in policy rates is expected, there is a growing risk it may signal the likely timing of its first rate cut will be brought forward from June. If that eventuates, EUR would likely weaken against the USD, dragging JPY along with it.

As for geopolitics, the rule of thumb is that if the tensions in the Middle East are subsiding, it should boost USD/JPY. If they escalate significantly, the likely repatriation of capital to Japan would weigh heavily on USD/JPY.

USD/JPY technical setup

With markets continued to pare rate cut expectations from the Fed, widening interest rate differentials with Japan, fundamentals suggest the bias for USD/JPY should be higher heading into the US inflation reports this week. However, with the threat of intervention from the BOJ elevated, rallies continue to suffocate on pushes towards resistance at 152, creating what I’ve described previously as a stalemate scenario.

With USD/JPY sandwiched by the intervention threat and bullish fundamentals, I’ll direct you to recent trade ideas that remain valid and have already worked since written. They can be accessed here and here.

The one overriding message is that while the technical picture looks bullish for USD/JPY, with a break of 152 pointing to the potential for substantial gains, the threat of BOJ intervention has greatly reduced the odds we’ll see significant upside should a topside break occur.

That suggests there’s limited reward and ample risk of going long on pushes toward 152. If the BOJ were to intervene, or even just signal such a move was imminent, USD/JPY could fall hundreds of pips in the space of seconds. As such, unless the Japanese government’s stance towards the weaker yen shifts substantially, selling rallies, rather than buying dips or breaks, remains the preferred strategy.

Resistance is located just below 152 with support located at 151.50, 151.20, 150.80 and 150.27. A more pronounced support zone is located between 149.58 and 149.00. Good luck!

-- Written by David Scutt

Follow David on Twitter @scutty

Via Forex.com

GVZ, or the gold volatility index, witnessed a strong move higher on Thursday as markets digested the recent Fed statement and latest summary of economic projections. The projections invalidated a growing belief in the market that the Fed will be forced to forgo a third rate cut in 2024 due to robust US data and resulted in a dovish repricing in the dollar. 

However, it has not taken long for markets to rally behind the dollar once again – something that is likely to keep the greenback supported into Friday’s PCE data which falls on Good Friday.

The chart below reveals gold’s recent responsiveness to the dollar (DXY) and shorter-term yields like the US 2-year yield. The aggressive move higher corresponded with falling yields and a lower USD but shortly thereafter,

Daily Gold Chart with DXY and 2-Year US Treasury Yields

Source: TradingView, prepared by Richard Snow

POTENTIAL EVENING STAR EMERGES MOMENTS AFTER PRINTING THE NEW ALL-TIME HIGH

An evening star could be emerging as the week came to a close, although the middle candle has a very notable upper wick which is not synonymous with the candle stick pattern. Nevertheless, price action suggests the recent move higher was an overreaction to the Fed news, as prices continued to ease into the weekend.

At the start of the coming week, the prior high of $2146.80 comes immediately into view as an early indication of whether bears may set the tone for the week. It’s a quiet week apart from final Q4 GDP data for the US and UK just to list a few and then on Friday PCE data for the month of Feb is due.

The dollars strong, immediate recovery poses a challenge for further upside for gold over the shorter-term and with few catalysts to choses from next week, gold may consolidate around the prior all time high with a view to trade lower.

Daily Gold Chart (XAU/USD)

Source: TradingView, prepared by Richard Snow

The weekly chart helps put golds multi-week advance into perspective. The week before the one that’s just passed revealed a bit of a slowdown in bullish momentum and the candle relating to the most recent trading week that’s just come to a close, reveals a rejection of higher prices.