The rally in the dollar recently has been quite unusual, not just in how strong it’s been but also the fact that everyone seems to be in agreement that there’s more to come. Usually in these circumstances the trade would begin to look crowded which can be a sign that the move is near exhaustion. However, I’m not sure that this will happen quite yet. This may be because there’s two things driving the euro lower against the dollar, a quantitative easing driven weak euro and a rate-hike driven strong dollar. Even so, this has been a very rapid decline in the pair and I wonder how much more there could be in the short term.
What impact will Wednesday’s FOMC announcement have?
I think this depends on what the Fed does on Wednesday. It has been widely suggested that it will withdraw its pledge to be “patient” in reference to raising interest rates which based on Chairwoman Janet Yellen’s previous comments removes the two meeting buffer on the first hike. Many see this as a sign that the Fed will raise interest rates in June (April effectively off the table due to the use of “patient” in its January statement) although I think Yellen will stress that this is not the case. In fact, weaker retail sales in the fourth quarter of last year along with no improvement in wage growth suggests to me that the Fed won’t raise rates until September regardless of whether “patient” is dropped or not.
What this means for EUR/USD in my view is that the removal of “patient” from the text could bring about one more push in the dollar before the long overdue correction, and a rather sizeable one at that. I’m not convinced we’d see parity even if this happens although I do think we’ll see it eventually and probably this year. If “patient” remains in the text then the correction could begin immediately as, in many people’s mind, that would push back the rate hike until at least September, if not later.
Of course we also need to consider other things aside from just that term. For example, the Fed will release its latest economic projections along with the dot plot of interest rate forecasts for each member of the Fed. While the Fed’s inclusion or exclusion of “patient” may trigger the initial moves in the markets, the economic projections and dot plots should not be ignored and could even have a greater impact. For example, the “patient” pledge may be removed but the dot plot show members forecasting later and slower hikes and the new economic projections showing slower growth and lower inflation. While this could bring initial dollar strength, due to the removal of “patient”, I believe the overall effect would be bearish for it.
What do the charts say?
Well, the daily chart doesn’t really throw up too many red flags. What is shows is a very strong selloff consisting of moves lower, consolidations and further declines. It’s all pretty textbook. The oscillators are also pretty standard, they are very overbought and have been for a long time, a typical picture for a pair that is in a strong downward trend.
The 4-hour chart on the other hand offers a few more clues. Bullish divergences between price action and the stochastic, MACD lines and histogram really stands out for me. The new low that was made was also not very convincing which suggests the pair is losing momentum ahead of the FOMC decision.
The pair is now testing the 20-period SMA to the upside, which is has traded below since 26 February and has acted as resistance during that period. A break above here would be an early warning sign that the pair is entering correction territory. Further confirmation could come from the pair breaking above Thursday’s high of 1.0683. This could also be seen as the neckline break of the double bottom, prompting a move towards 1.09 – 1.0920, based on the size of the formation. This would coincide with 9 March highs.
Final confirmation would come from the break of the declining trend line from 26 February highs and the 50-period SMA.
Of course, Wednesday could change everything so as traders, it’s important to be careful around such major events that can bring enormous volatility.
