Inflation divergence, US politics, political risk in Europe and seasonal factors could mean EUR/USD sees further downside in December.

December often brings weakness for the EUR/USD pair as the by-now annual debate on the US debt ceiling fosters a temporary risk-off mood among traders, boosting the Dollar, while the seasonal USD liquidity demands of European financial firms can also push the pair lower.

“We admit that there has been plenty of technical damage done to the dollar as evident in a DXY index below its uptrend and a EUR/USD breaking above its downtrend,” says Martin Enlund, chief analyst at Nordea Markets. “But dollar-positive year-end effects as well as improving US inflation vs EA inflation still point in the direction of a lower EUR/USD.”

EUR/USD shown at daily intervals. Captures summer gains and autumn correction.

US inflation rose in October, with core CPI edging up 20 basis points to 1.8%, while core Eurozone inflation slipped lower by 20 basis points to 0.9% for the month.

Both sets of data served to reinforce existing central bank narratives, with stronger US inflation favouring a tighter Fed and the subdued trend in European price pressures auguring an easy-ECB.

“Business sentiment should increasingly feel adverse effects from a stronger EUR,” Enlund adds. “The trade-weighted EUR is currently at its strongest level since the middle of 2014 as well as up by 7% year-to-date.”

The Euro-to-Dollar rate has risen by close to 12% in 2017 after traders marked down an overbought Dollar and piled into the Euro when Mario Draghi hinted in June that the European Central Bank could soon begin winding down its quantitative easing (bond buying) program.

“We expect PMI’s to indicate a slowdown in EMU growth in coming months, probably already this week (November 23),” says Enlund. “And this will happen at a time when many economists, investors and politicians are extremely bullish the Euro Area as well as the political project,” Enlund adds.”

Euro gains have also been supported by increasingly positive sentiment toward the political and economic bloc after a series of elections passed without any major adverse event.

“We recommend going short at 1.1850 (or to keep your shorts). We also think the USD has more to give vs the commodity bloc, but remain negative the USD/JPY,” says Enlund.

Many had feared a continued rise of anti-Euro and anti-European Union parties during the Dutch, French and German elections of 2017, making political risk a central theme for currency markets.

“While investors have been squarely focused on the prospects for tax reform, we note that market attention will shift soon to the US debt ceiling and appropriations debate ending December 8,” says Hans Redeker, head of global FX strategy at Morgan Stanley.

Sunday’s failure of talks to build a coalition government in Germany may add further baggage around the ankles of the Euro over the coming weeks, subject to whether another general election becomes necessary.

“Historically, USD tends to appreciate during these periods as risk sentiment temporarily wanes, though we believe this offers an opportunity to re-enter USD bearish positions,” adds Redeker.

Combined with monetary policy divergence, Washington politics and other seasonal factors, a renewed flaring of political risk in Europe could mean EUR/USD’s recent woes have further to run still.

The Euro-to-Dollar rate was quoted 0.07% higher at 1.1791 during early trading in London Monday although it saw lows in the 1.1725 area overnight and around the London open.

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