Earlier this month, we warned about the widely-watched inverse head-and-shoulders pattern in the US dollar index, noting that:
"One paradoxical reason for caution toward the greenback is that the inverted head-and-shoulders is a bit too perfect; rarely do you see a picture-perfect technical pattern evolve exactly as the textbook suggests...More saliently, there may be little in the way of positive economic catalysts for the US economy."
Over the last couple of weeks, a couple of factors have conspired to completely "flip the script" when it comes to the dollar index and EUR/USD specifically. Of late, Federal Reserve officials have been publicly expressing more concern about the stubbornly low rate of inflation. While a rate hike next month is still essentially a foregone conclusion, the market-implied odds of three, and potentially even two, increases next year are fading as a result.
Meanwhile on the other side of the Atlantic, the minutes from the ECB’s October policy meeting hinted that the Bank may be preparing to wind down asset purchases when the current program expires in September. Instead of linking its QE program directly to the level of inflation, the ECB may instead make a vaguer pledge to keep policy generally loose until price pressures pick up.
Technically speaking, EUR/USD (which composes nearly 60% of the dollar index) has gone from showing a head-and-shoulders topping pattern (pink) to a inverted head-and-shoulders continuation pattern (blue). The current setup suggests that the world's most widely traded currency pair could retest its 3-year high near 1.2090, with an eventual "measured move" target all the way up above 1.2200.
Source: TradingView
Of course, like any single indicator, the current bullish pattern could fail as well; after all, EUR/USD is certainly relatively overbought on a short-term basis, and any progress on the US Senate's tax reform vote or the release of the October Core PCE later this week could reinvigorate the greenback. But as it currently stands, both the trend and recent technical pattern favor continued EUR/USD strength as long as rates can hold above previous-resistance-turned-support in the mid-1.1800s.