EUR growth slowly picking up in near term

EUR/USD has been range-bound, for the last six months, trading 1.05-1.15. As the first Fed hike approaches, EUR/USD is to break out of the 1.08-1.12 range to the downside but still think that there are better ways than EUR/USD to play Fed hikes in G10. 

While the Euro area still has a large output gap (~2%/GDP according to IMF estimates), growth is picking up slowly. Another quarter of 0.4%q/q growth is expected in Q2 with growth of 1.5% for the year.

Conditions across the Euro area are slowly normalising, with positive credit growth in the core and a slowing pace of contraction in the periphery. And despite frequent talk of "currency wars"/competitive devaluations, Euro area normalisation is a domestic story driven by domestic demand.

"But that has been turned on its head, the correlation is now negative, albeit not as strongly significant. If equities lose steam as the Fed hikes rates, EUR may find some support on the crosses. EUR/CAD, EUR/AUD and EUR/GBP show significant (negative) correlations to equity returns (though EUR/GBP is more likely to be dominated by expectations for the BoE)", says RBC capital markets.

Trade actually subtracted from growth in Q1 and a negligible contribution is expected in Q2. EUR/USD is also kept rangebound by its changing status as a risk-on/risk-off proxy. At the height of the Eurozone crisis in 2012, EUR/USD had reached a 0.8 positive correlation to S&P returns. 

"Technically, although EUR/USD has been in a sideways consolidation, the recent series of "lower highs" indicates that the market is turning more bearish again. Moves to resistance at 1.1052 and 1.1258 are expected to attract selling pressure for a test of very important double bottom support at 1.0819", added RBC capital markets. 

A daily close below this level would be a very bearish medium-term development, with the breakout exposing 1.0660 and 1.0521.