With the euro to dollar exchange rate in retreat we consider how far the decline will extend.
Today sees the EUR/USD attempt to build support following what has been a tough week with the pair falling from above 1.1450 to the 1.1250 area we are currently witnessing.
The movement is being largely diven by the dollar which has recoverd to over a two-week high against a basket of its major rivals today as generally improved risk appetite in global financial markets was seen as lowering the bar for Fed policy tightening in the months ahead.
The USD has struggled in 2016 though, falling to a five and a half-month trough against its major trading partners last week thanks to moderating expectations for Fed rate hikes this year.
The EUR/USD pair is showing an increasing number of bearish signs as a result, indicating a possible more sustained move lower again, back into the centre of a long-term range the pair has been trading in since early 2015.
What seems highly unlikely is a move back up to the range highs, at least any-time in the short-term horizon.
Bears have aggressively sold the pair after it knocked on the trap-door of the range ceiling in the 1.14s. It is currently trading in the 1.1260s.
An improvement in the outlook for the global economy as a result of better-than-expected China data, appears to have been the catalyst for the move lower, as this makes it more likely the Federal Reserve will raise interest rates sooner in the U.S.
Higher interest rates would support the dollar as they attract greater flows of foreign capital seeking higher rates of return.
In the minutes from their latest meeting, the Fed said that global factors were a major reason for them delaying raising interest rates but there is a possibility this obstacle may now be lifting.
Short-term Technical Forecast
Since EUR/USD is in a long-term, range-bound market, you need to zoom in to lower timeframes, such as the 4-hour to try to get a feel for where price action might be going next.
The chart below shows how the pair was in a mini-up-trend within the range which rose up to 1.14 and then started going sideways for about a week. Yesterday this sideways move broke down and out of its range. This appears to be the start of a new mini-trend lower, however, it’s too soon to say for sure.
Whilst it looks highly unlikely the pair will recover and return to the range highs in its next move, we would ideally be looking for a break below the hammer candle lows at 1.1233 for confirmation of further downside.
Such a move would also show a reversal of the peaks and troughs. From previously rising during the up-trend, they would now be falling, with two lower highs and two lower lows confirming the infant down-trend.
Unfortunately, there is not much scope for further downside, as the S2 monthly pivot is situated at 1.1200 and this would be expected to block the falling exchange rate as traders will cluster buy orders tat that level in expectation of a bounce.
Even if there is a break below the pivot the 50-day moving average (MA) and the 200-week MA are both situated not far below, close to each other in the 1.1175-80 region. Like the pivots these tend to stall price action, forcing it to pause, bounce or even reverse.
The MACD indicator in the bottom pane is below zero and therefore in bearish trend territory, further supporting the negative forecast.
Swissquote’s chart compelling
If we look now at a chart from Broker’s Swissquote, they have noted a further bearish cue, in the shape of a rising wedge pattern.
This bearish formation provides compelling evidence the pair will go even lower than their current level in the 1.1260s. Exchange rates have already broken below the lower boundary of the wedge pattern; the expectations is that they will fall at least 61.8% of the height of the wedge at its tallest point down (which is about 300 points). By my calculations that’s about 200 points down from the break point in the lower 1.13s, giving a minimum price expectation in the lower 1.11s.
Swissquote themselves point out that support lies at 1.1144, so there is a strong possibility that along with the target calculated from the wedge the exchange rate will reach 1.1144.
Two-Year Treasuries Also showing Positive Signs
A strong indicator of dollar strength is the two-year Treasury yield. This shows the interest 2-year US government bonds pay investors.
It is often used as a gauge for inflation expectations, as treasury bond holders want to be earning above inflation, so when inflation expectations rise, so do Treasury rates - or yields as they are called.
When yields rise, therefore, it’s because inflation could be about to, and this means there is more chance the Federal Reserve will raise interest rates to cool things down.
As mentioned before higher interest rates attract swathes of foreign capital and therefore increase demand for dollar, which appreciates.
Thus, a rise in yields = a positive for the US dollar.
The chart below shows the two-year treasury yield having formed a rounding bottom pattern which looks like it is about to break out above key resistance at 0.7666. If it breaks higher as looks probable, it should move rapidly higher.
This will lead to an appreciation of the dollar, which will mean the EUR/USD will fall, therefore further supporting our short-term bearish outlook for the pair.
The positive MACD ringed at the bottom of the chart, is above the zero line in bullish territory further adding confidence to the foecast.