This Great Graphic depicts the top the euro is carving. We suggest that several fundamental developments lie behind the price action. Interest-rate differentials are widening, which favors the US. Speculative market positioning is leaning heavily long euros. With European politics no longer the tailwind it once was, it's not surprising the euro appears to be carving out a top.
There's increased speculation that the ECB's asset purchases will continue well into next year, even if at a slower pace. The divergence between the Fed's balance sheet, which has begun shrinking, and the ECB's balance sheet has not peaked. Indeed, even if, after the ECB's balance sheet stops expanding, peak divergence lies ahead as the Fed's balance sheet will likely continue to shrink in 2019.
We had been tracking a head-and-shoulders topping pattern in the euro. The neckline is shown in red. As that pattern was being traced in September, the euro fell, snapping a six-month uptrend. The importance of the technical patterns is that they offer a price projection. We suggested that a conservative target was $1.1600. The euro reached $1.1670 on October 6. This matched the mid-August low before the euro bounced.
The white line in the chart connects that mid-August low with the early October low. It is the neckline of a larger head-and-shoulders pattern. Last week's rally seemed to have formed the right shoulder. The high was around $1.1880, which also corresponded to a 50% retracement of the decline from the year's high on September 8, near $1.2090. The left shoulder peaked near $1.1910.
In essence, the first head-and-shoulders pattern was part of the head of a larger head-and-shoulders pattern. Even if one does not subscribe to technical analysis, the takeaway may be important. First, the bearish technical view would be weakened by a euro move back above the larger shoulders ($1.1880-$1.1910). Second, a break of the $1.1660 area could spur further liquidation of long euro speculative positions. A break of $1.1600 would signal a move toward $1.1250, not far from the 50% retracement of this year's euro advance.
The technical indicators on the daily charts are not generating particularly robust signals, but signals from the weekly charts lend credence to the bearish pattern discussed. Moreover, our assessment of the macroeconomic conditions, the widening interest-rate differentials and the prospect that ECB purchases extend longer than previously anticipated, which in turn would defer the ECB's first rate hike, supports the technical view. At the same time, the technical analysis offers a level for risk and money-management purposes that would weaken this view.