Euro-to-Dollar Rate At Risk As Bearish Head-and-Shoulders Topping Pattern Develops

The Euro-to-Dollar exchange rate has formed a bearish topping pattern ahead of October’s monetary policy announcement from the European Central Bank Thursday.

The Euro-to-Dollar pair is still trading within a broad range although the longer it continues to move sideways the more we see scope for downside.

The outline of a possible bearish head-and-shoulders (H&S) topping pattern is beginning to form. We note the clear outline of the 'head' (H) formed during August and September, and now also with Friday's down-day, a right shoulder (S) appearing on the chart.

The fact the 50-day moving average (MA) capped upside for the pair on Friday also suggests more downside to come.

Although it has yet to be confirmed, a break below the neckline at 1.1670 would confirm a bona fide H&S is breaking down.

In such an eventuality, our first downside target would be at the S2 monthly pivot around 1.1500 - and then at the 'official' target for the H&S, which is traditionally calculated by taking the height of the pattern and extrapolating it down. This reaches to roughly 1.1300.

The MACD momentum indicator has been steadily falling during the formation of the pattern, which is in line with its bearish expectations.

The monthly, long-term, chart is also showing the exchange rate touching, but then being rejected by the 50-month MA, which is currently at 1.1814.

This and this adds bearish connotations to the overall picture as a hefty amount of orders are likely located around this level.

Data, and Events That Could Move the Euro

The main event for the Eurozone in the week ahead is the meeting of the European Central Bank (ECB) to decide monetary policy, on Thursday, October 26 at 12.45 BST.

Back in June the ECB said it would discuss a gradual reduction of its QE stimulus programme - otherwise known as "tapering" in the "fall".

Given this will be their last opportunity to announce their tapering programme before the onset of winter most analysts are taking them on their word and expecting a detailed announcement.

Currently, the ECB buys 60bn of bonds per month as part of its programme, but most see this being reduced to 40bn for a period of 6 months.

Others expect a deeper cut to the monthly amount -  from 60bn down to 30 or 25bn but for a longer duration of 9-12 months, these include Societe Generale's Chief FX Strategist Kit Juckes, and TD Securities' Chief Macro Strategist Jacques Douglas, who's ideas we have discussed in more detail here.

There is an argument that the ECB will try to taper as gradually and slowly as possible to keep the Euro anchored given recent misgivings that its increased strength might upset growth.

"Last month, the ECB suggested that not all decisions will be made at this month's meeting because the euro was a source of uncertainty but the currency is now trading at 1.18 instead of 1.20 so they should not be as worried," says BK Asset Management's Managing Director, Kathy Lien.  

Lien thinks the ECB will opt for a 'dovish taper' by which she means, "cutting bond purchases by only 20B and extend it to September or beyond because they can always adjust it later and right now there's too much political uncertainty."

If she is right, she thinks the Euro will fall after the announcement, in line with most analysts; if wrong and the "ECB marries a more aggressive reduction with hawkish comments from Draghi, EUR/USD will hit 1.20 easily."

On the hard-data front, the main release for the Euro will be PMI data on Tuesday at 10.00 BST.

Both Manufacturing and Services PMI's are expected to slip in October, with the former expected to come out at 57.8 from 58.1 and the later to come down to 58.7 from 58.8.

Nevertheless, despite expecting them to fall, IHS Markit who compile the data, view PMI's as broadly good and a reflection of the steady uptrend in regional growth.

"Both the degree to which output is rising and the extent to which price pressures have intensified are consistent with the ECB starting to rein in its stimulus," says IHS Markit's Principle Economist, Bernard Aw.  

"The flash October PMI data will, therefore, play an essential role in gauging the health of the economy as we approach the end of the year, and thereby provide further insights on future monetary policy," adds the economist.

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Data, and Events the Could Move the Dollar

The Dollar got a bump last week as a result of heightened expectations that Trump might get his tax reforms ratified after the Senate okayed his budget, although analysts say it is a long road ahead.

Nevertheless, any further positive news on tax reforms will provide the Dollar with a strong backdraught in the coming week.

On the hard-data front, the first estimates of US PMIs for October are released at 14.45 BST on Tuesday, October 24.

These are likely to be of special interest because they will provide the first estimates of economic activity post-hurricane, and thus a gauge of the "rebuilding efforts", says IHS Markit's Aw.

The figures are forecast to show a rise in Manufacturing from 53.1 to 53.6 and for Services from 55.3 to 55.6.

Next major release for USD could be Durable Goods Orders out at 13.30 on Wednesday.

Durable Goods are expected to rise by 1.0% in September, compared to 1.7% in the previous month of August, and ex large transport orders by 0.5% from 0.2% previously.

Friday will see the next major release for the Dollar in the week ahead, third quarter GDP data, out at 13.30.  

The market is forecasting a 2.5% rise compared to the same quarter in 2016.  This is below the 3.1% recorded in the second quarter but only because of the impact of the hurricanes.

Canadian investment bank, TD Securities, think the market is just about right and also forecast a 2.5% rise - clearly, the release will be crucial for clarifying the extent of the damage from the hurricanes.

There is an outside chance Donald Trump may announce the new head of the Federal Reserve next week, although his deadline was November 3.