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Forex: Time for a meaningful correction in EUR/USD?

The Euro continues to relax lower against a more challenging U.S. Dollar. The pair approaches the European session over 200 pips off its cycle highs with the key confluence support at 1.3480 now in danger.

The correction comes with technicals screaming it was time to take a breather, while fundamentals supported the decline after a big blow on European bond yields, with the Spanish 10-year paper back above 5.4% and the IBEX35 tumbling 4%.

As Kathy Lien, co-founder at BK Asset Management, notes: "While the sell-off in the EUR/USD was caused by political uncertainty in Spain, even without the calls for Spanish Prime Minister Rajoy to resign, the Euro was due for a correction."

"The European Central Bank has a monetary policy meeting this week and while their message is not expected to change, it will be difficult for Mario Draghi to avoid talking about the currency" adds Kathy, suspecting that ECB's Draghi is unlikely to talk about the levels of the Euro, which "will be probably interpreted as continued comfort with the EUR/USD level."

In a Bloomberg interview, according to founder and chairman of FX Concepts' currency hedge fund John Taylor: “We’re positioned for euro rallies and dollar weakness. The first LTRO flows are over, so we have a month before we have the next ones, and so in the first part of February the euro is probably going to relax and maybe go sideways to down.”

An analyst that agrees with Mr. Taylor's view is Greg Gibbs, currency strategist at RBS, saying that "after Monday's pullback off highs, a further decline in coming weeks leading into the Italian election reversing its little blowout above 1.35 appears likely."

Greg adds: "EUR/USD is hovering just above 1.35, a level that appeared to trigger significant stop loss buying last week. This suggests there is likely to be stop losses below that level. EUR can fall several big figures and still appear in a rising trend from its lows in July. As such it feels vulnerable to a bigger correction just on uncertainty over coming weeks."

In the short run, in view of Ivan Delgado, head of Asian editors at FXstreet.com: "The real test to measure the commitment of sellers will come at 1.3480 - Feb 28 high, 50% fib from latest run up from 1.3260 - , where traders will have to pay close attention to price action. A break below exposes a possible return to the 20-day EMA at 1.34/1.3410, while a recovery off contention area 1.3480 should target and regain the 20-hourly EMA, to resume upward tendencies."

Sean Lee, founder at FXWW, notes: "EUR/USD will find strong technical support 1.3410/30 and buying any dips towards these levels, in line with the recent trend, is the most sensible strategy. I’d plan for some extended volatility here, so 100 pips either way, and not look for any bearish entry levels until 1.3615/25."

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