The EURUSD has been in an uptrend since July 2012. Recent monetary policy changes have triggered a sell off in the pair creating speculation that the uptrend has concluded, The reversal in progress, has the capacity to take the pair much lower, this article will shed some light on the catalyst required to drive the trend change, as well as a trade plan.



Fundamental Outlook



Disinflation remains a concern for the Eurozone. HICP is the measure of inflation used by the ECB. The most recent reading came in at 0.5%, while targets are to be as close to 2% without going over.



Figure 1.1 - HICP on steady decline after a high of 3% posted on September 2011

The ECB has several different tools for battling disinflation. In April, an attempt at verbal intervention was made. See my blog post from April 12 - Possible EURO sell off at Open for details. The results was a 20 pip gap down, followed up with a 2 day sell off taking the pair 90 pips lower. The method proved to be ineffective as buyers stepped in and did not allow the pair to close lower.

The ECB Press conference on May 8, however had a major impact when Draghi indicated a clear time frame for when action would be taken.


Figure 1.2 - EURUSD 1 Min chart during ECB Press Conference


Although the press conference started with Draghi stating in the first minute that interest rate will remain unchanged, and economic recover was inline with expectations, the bullish momentum took a turn in the QA session when Draghi made the statement:


The governing counsel is comfortable with acting next time.


The verbiage had a rapid 150 pip move to the downside, where after a brief pause, the price continued toward the 1.3750 area (250 pips lower) to close out the week. The following week experienced further selling as the expectation of action loomed. The total price movement for the pair as a cause of that statement was 405 pips, as a bottom was made at 1.3587.


On June 5, the Interest rate cut was announced. The chart below explains the price action.


Figure 1.3 - June 5 - Minimum Bid Rate, Followed by ECB Press ConferenceThe initial Reaction after a spike up was a mere 64 pip move to the downside. Followed by some consolidation prior to the press conference, where the move bottomed out at 1.3503 for a total move of 128 pips to the downside.

Figure 1.4 - Price action comparison - announcement of intent vs action
The ratio of the two price movements indicates that the market was largely expecting the rate cut to occur. Further it is clear from the above chart that the rate cut was priced in ahead of the announcement.

Moving forward, we can see as of today's date (July 11), over a month after the fact, the pair has not been able to break the low set at the time of the rate cut. This gives a clear indication that the market requires a catalyst for a break of the low.

The ECB was effective at moving pair down over 500 pips via a rate cut, but at this point they will want to determine it's effects on inflation. The next HICP and related numbers (CPI, Producer Price, Core CPI etc), will be closely scrutinized to determine early effects of a lower exchange rate on inflation.

As the ECB awaits these releases to further assess their monetary policy, trader's are pushing the price higher via profit taking.

If the initial impact on these numbers is low, it can potentially give reason for other measures to be taken. QE is a measure that will be much more effective at driving the EURO lower. It is arguably the most powerful tool that the ECB has. However, we will most likely need to see a combination of the EURUSD edging higher while inflation continues to show no sign of improvement.

The bottom line is that further action will most likely be required from the ECB to break the current lows.


Even though it has been the ECB that has largely been pushing the price down, there are some U.S numbers to be mindful of.


Figure 2.1 - US Inflation Jan 2010 to Current
After hitting 1.1% earlier this year in Feb, inflation has risen and is currently sitting comfortably at target levels.

It is important to note however, that Yellen is a strong believe of the "The Phillips Curve" method of economics. This method relies less on inflation and carries more importance to unemployment. The belief is that inflation is inversely related to unemployment.



Figure 2.2 - Unemployment rate Jan 2010 to current

It is clear that these numbers, which carry a major significance to Yellen and the Fed, are at target levels. Although Yellen has recently cited problematic emerging markets, poor housing market recovery and geopolitical tensions, these factors do not carry nearly as much importance as the sole unemployment number.

As much as the Fed is not giving the rate hike intentions the considerations it deserves, it is inevitable the market will commence pricing it in if these stats remain at current levels.


Conclusion

The Fundamental outlook for the Euro zone supports a broader bearish bias, however some form of a catalyst may be required as the recent rate cut appears to be priced in. As trader's await further direction from the ECB, we may see continued bullish momentum in shorter cycles, through profit taking, and lack of selling pressure as trader's allow development.

A Catalyst may appear via USD Strength, although the probability remains low unless further talks regarding a rate hike emerge.


Technical Outlook

The chart below shows an Elliott Wave analysis on the daily chart

Figure 3.1 - Daily EURUSD Elliott Wave AnalysisThe above chart shows the second leg up in the pair on the daily chart. The starting point for this wave is 1.2758. We can see the (A), (B), (C) structure taking form and ending at 1.3967. For ease of viewing, the 3 wave move has been marked by the green dotted line. The wave indicates the high in place at 1.3967 to have occurred on March 13.

The marginal peak above the 1.3967 on May 8 at 1.3993, is consider to be part of an irregular expanded flat correction which has finished at 1.3503.

At this point as the flat correction has finished, we can either resume the uptrend or continue lower for the formation to turn into a double correction.

Figure 3.2 - Retracement levels and targets
So far we have retraced to the 38.2% Fib level. This is a quite shallow retracement reserved for only the most bullish scenarios. Although the there is no guarantee a second leg could emerge to take the pair lower, the probability is favored.

At this point, we look for the completion of (B) to initiate the next wave to the downside, wave (C). The targets for wave (C) at this moment will be the 61.8% retracement, which comes in at 1.3218.

Figure 3.3 - EURUSD Daily preferred path

The above chart indicates the most preferred wave structured. At the present moment we can already see (B) subdividing into a three wave structure as marked on the chart. The 61.8% retracement would give symmetry of the first leg up in the (B) wave and is a highly respected Fib level.


Figure 3.4 - EURUSD Daily 3800/3810 Resistance Area

Aside from a 61.8%, the above chart clearly shows the significance of the 3800/3810 area. Giving more conviction for the completion of the (B) wave in that area.

The daily wave count has remained unchanged since published to my Dukascopy blog on April 16. Targets at that time was the 50% retracement at 1.3361 which is the only aspect of the view that has been changed. However, Elliott Wave is quite subjective, wave counts can change, and can differ from one analyst to another.

Conclusion

The Fundamental outlook on this pair supports further bearish momentum in this pair in the form of another leg to the downside. A catalyst of some form is required to renew selling pressure, which indicates a potential bullish move in the interm. Analysis also gives good indication that a temporary bottom is in place. The Technical outlook supports a temporary bottom with a Wave count indicating an irregular expanded flat structure has completed. The Wave structure calls for a connector wave (B wave) of bullishness before the next leg of downside. The current retracement is quite shallow supporting a second leg to the downside.

Alternate scenario's

  • The wave count can potentially show the (B) as completed, with (C) on it's way. The retracement has been shallow but with the bearish nature of the pair, this view cannot be ruled out. A break of 1.3525 (88.8% of 3503 to 3700) would confirm that the (C) wave has begun
  • A retest of the 1.3525 area can setup a flat (B) wave to end at the 50% retracement at 1.3735
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