08.08.201910:17 Forex Analysis & Reviews: Carry-trade liquidation will support EUR/USD

EUR/USD has consolidated above 1.1200 on Thursday with no breakout in volatility.

Amid extremely low interest rates in the euro area, the euro is seen as a favourite funding currency for carry trades. An increase in risk aversion will, however, have an important impact and will lead to a closing of these positions which could trigger a sharp round of short covering.

The eurozone also runs a substantial current account surplus of around 3.0% of GDP which will provide important defensive support when risk appetite deteriorates.

German benchmark 10-year yields declined to a fresh record low of -0.60% during Wednesday amid defensive inflows before a limited correction to around -0.55% on Thursday.

Investors have strong expectations of the ECB monetary easing at the September policy meeting with prospects for a rate cut and re-introduction of bond purchases.

Political factors will also remain important given ongoing Brexit jitters, especially given economic vulnerability of the UK.

Most attention is still given to the UK economy and implications of any 'no-deal' Brexit outcome, but hard Brexit will make an important negative impact on the eurozone's economy. Amid sluggish manufacturing activity in Germany, there would be very serious implications in the event of trade disruption and EU leaders may offer some concessions.

Political relations with the US will also be an important obstacle that will worsen global trade tensions.

President Trump is already on the warpath over trade practices and has made persistent allegations of currency manipulation. A very aggressive ECB stance would further antagonise the US Administration and increase the threat of trade sanctions or currency intervention.

Central bank politics will also be important, especially with IMF head Lagarde due to take office as the ECB President in November. There is a strong probability that fiscal and monetary policy will become more integrated, potentially increasing government spending and easing pressure on interest rates.

A long-term reversal will not be signaled without a break above the 1.1400 area.