EUR/USD in eye of a storm that could become hurricane

July 19 (Reuters) – The EUR/USD is consolidating a massive sell-off after reaching parity just before the Federal Reserve hikes interest rates substantially on July 27. Should the European Central Bank not match its U.S. counterpart the pair is likely to fall further below parity and with traders badly prepared for that the pace of losses could rapidly accelerate.

EUR/USD has fallen 1.2135-0.9952 EBS since the Federal Reserve signaled a taper at its June meeting in 2021. Speculators have since rarely ventured short and bets on a drop remain negligible, representing no restraint on the decline. Economists have consistently predicted a rally and still are, and there is scarcity of option expiries under 0.9900, suggesting traders are ill-prepared for a deeper drop.

The one-year forward swap has widened from around 90 points in June 2021 to 280 today and if ECB sticks to its plans and only hikes by 25bps this month the interest rate divide will soon widen weighing EUR/USD.

With the Fed shrinking its balance sheet while the ECB’s continues to grow, EUR/USD could soon reach the next tech downside target for the move inspired by the Fed at 0.9688, and could fall well below that by year-end.

(Jeremy Boulton is a Reuters market analyst. The views expressed are his own, Editing by Ed Osmond)