Euro-to-US Dollar Completing Topping Pattern and Forecast to Fall in Coming Week

The Euro-to-US Dollar is looking extremely bearish at the start of the new week as low inflation and political risk weigh on the Euro and the Dollar continues its run of good form.  

The Euro-to-US Dollar has formed a head-and-shoulders (H&S) topping pattern (see below), which is made up of three peaks, the central one of which is taller (the head) than the two either side (the shoulders), which are usually about the same height. 

The exchange rate has now also broken below the level drawn by a line between the two intervening troughs of the pattern, which is called the neckline. 

This represents a significant break and provides confirmation that the pattern has completed and is indeed fulfilling its potential to break lower.

From here the exchange rate is expected to fall a similar distance as the height of the H&S at its tallest point extrapolated lower from the neckline, which in this case gives a target of 1.1200.

The 200-day moving average (MA) at 1.1245, however, is likely to present a formidable obstacle to further downside which is why we have made 1.1250 our final downside target for the pair.

An interim target for the pair is 1.1500 which is at the level of the S2 monthly pivot, which is another formidable obstacle.

Monthly pivots in a downtrend attract a lot of buying interest as traders often use them to trade counter-trend bounces, and prices often stall, rebound or even reverse after touching them, however, in this case, we would expect the pair to break through the S2 and eventually fulfill its 1.1245 target.

A break first below Friday's lows at 1.1575 would confirm a continuation down to the 1.1500 interim target.

A further break below 1.1450 would then confirm a  continuation down to a target at 1.1250.

News, events, and data for the Euro

The Euro fell dramatically following the European Central Bank (ECB) meeting last week when the ECB announced how it would wind down its stimulus programme.

The Euro fell after the market assessed the ECB was not removing stimulus - which is negative for the Euro - rapidly enough.

The slow pace of stimulus removal means it is unlikely the ECB will raise interest rates until the back end of 2018.

Higher interest rates tend to strengthen currencies by attracting more capital inflows, so the knowledge that the ECB is not expecting to raise them for a whole year, was a blow for the Euro, especially when compared to most other central banks which are already raising rates.

Given this emphasis, a major release in the week ahead will by Eurozone inflation data at 10.00 (UK) on Tuesday 31, since inflation is a major driver of interest rates.

All that Euro bulls can hope for is that inflation data for October shows a faster-than-expected rise in inflation as this might indicate interest rates will have to be raised earlier. 

Yet according to Lloyds Commercial Banking's Senior Economist Rhys Herbert, the opposite is more likely and inflation in October will probably come out lower due to the base effect of lower oil prices.

"Owing to energy price base effects, we forecast headline CPI inflation to tick down to 1.4%y/y in October from 1.5%y/y in September," said Herbert. 

The impact of base effects is likely to worsen over time not get better:

"These negative base effects will intensify in the coming months, potentially pushing headline inflation towards 1% early next year," he added.

Strip out the volatile oil and food components and inflation remains static at 1.1%, and only a rise in 'core' inflation from there could help the Euro get over the negative expectations raised at the ECB meeting.

"A better guide to underlying price pressures is ‘core’ inflation, which excludes food and energy. We forecast core CPI to be unchanged at 1.1%y/y in October and, while it has ticked higher in recent months, it is still well below target," said Herbert.

Viva Catalonia!

Market analysts have changed their mind over how influential the political drama in Catalonia is for the Euro.

From being considered market moving initially it's influenced subsided.

Yet now once again it appears to be coming to the fore again as a negative driver for the Euro, although its magnitude is difficult to ascertain.

Spain has got heavy handed with the Catalan's after they unilaterally announced independence with the latest twist in the drama consisting in Spanish PM Rajoy basically re-annexing Catalonia, sacking the entire government and announcing elections on December 21 to decide the matter.

Yet the Catalan PM Puigdemont does not support the idea of elections and continues to claim Catalonia is independent; people are taking the streets of Barcelona waving Catalan flags, and general chaos reigns.

Clearly how the drama unfolds and whether it escalates or eases will be a contributory factor for the Euro in the coming week.

News, Data, and Events for the Dollar

Next week is going to be a busy week for the US Dollar with four major economic news releases and events on the calendar.

The first of these is the meeting of the central bank on Wednesday 1 at 18.00 (UK) to decide interest rates.

The Federal Reserve is not expected to change rates at the meeting on Wednesday but rather to wait until the following month of December when it is widely expected to raise rates instead.

Raising rates will be positive for the Dollar as higher interest rates attract more inflows of foreign capital from international investors seeking better rates of return on their money.

Currently, expectations are firmly set for a rate hike in December but if the Fed says anything to question that in its statement, the Dollar could fall.

Inflation is still considered a little low, for example, and if this is raised as a significant concern by members of the Fed it will bring into doubt the December hike and the Dollar may weaken as a result.

Speaking of the Fed, President Donald Trump is also expected to announce the next President of the Fed before Friday, November 3.

Currently, it is a three horse race between Jerome Powell, Janet Yellen, and John Taylor.

The most positive next president for the Dollar would be Taylor who invented the 'Taylor Rule' which is a sliding indicator of what level the central bank should set interest rates depending on the level of inflation.

The Taylor Rule currently indicates interest rates should be substantially higher so if Taylor was elected the next Fed head he would be expected to raise them pretty quickly, strengthening the Dollar in the process.

Powell and Yellen already sit on the governing board so are seen as Dollar-neutral choices.

Given the substantial upside potential which already exists for the Dollar as a result of possible reforms to the tax system, and that an overly strong Dollar is not desired by the administration as it makes exports less competitive, Trump will probably not choose Taylor.

If he does, however, expect steep upside in Dollar-pairs.

The Non-Farm Payrolls labour report is also out in the coming week, on Friday, November 3.

After the shock fall in payrolls in September (-33k) which was caused by the impact of the hurricanes, the October figure is forecast to show a substantial rebound, with the consensus of economists forecast estimating a 315k rise.

Some are even more optimistic, seeing a 400k+ rebound as possible, such as analysts at investment bank TD Securities in Canada.

"We expect payrolls to give back their hurricane-induced weakness and post a 330k gain, with scope for surprise in either direction. Assuming a hurricane drag of 200-250k and an underlying trend of +175-200k, October payrolls could easily print close to +400k or higher," they said.