Euro / Dollar Rate "Breakout" Only Confirmed Once 1.1550 Achieved

Euro / Dollar Rate "Breakout" Only Confirmed Once 1.1550 Achieved

30 March 2016, 20:03
Vasilii Apostolidi

The EUR/USD pair is knocking at the door of its range highs, we explore several possible future scenarios for the pair.

Despite a recent pick-up, EUR/USD remains overall range-bound in a move which has been extending sideways between roughly 1.05 and 1.15 for over a year.

Some analysts see this sideways consolidation as providing the ‘base-work’ for a stronger eventual recovery higher - citing the 1.20s as a potential target-zone.

There is also the fact that the pair is currently trading above its 20, 50 and 100 moving averages – a further bullish indication.

Nevertheless, for confirmation of more upside, a clearer breakout higher would be required, but prices remain trapped within the range.

The Chaikin Money Flow Index (MFI) is often employed by analysts trying to determine the likely direction of a range breakout whilst the range is still going sideways, and whilst it has not yet given a bullish signal, it looks like it will probably poke higher to complete a three wave pattern on the weekly chart (see below) which would indicate a strong move higher.

From the point of view of the long-term trend, there is still insufficient evidence yet that the pair has reversed from bear to bull, which means our base case stance remains that the pair will extend further sideways or break lower in line with the dominant down-trend.

As such a break below the 1.04 lows would confirm a move down all the way to parity (1.0000).

The exchange rate is currently in the mid 1.13s as it presses higher following cautious commentary from the head of the Federal Reserve, who suggested US interest rates might stay low for longer than markets had been expecting. Low interest rates cheapen a currency as foreign investors are not as attracted to invest their capital in a low-interest environment, due to lower returns. 

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Top of Range Blurred 

Long ranges provide traders with the ideal opportunity to trade the breakout.

However, one problem with this particular range is determining where the top of the range in fact is, and thus when the pair has in fact properly broken out.

Whilst there is a cluster of highs in the 1.13s forming a ceiling, the whole year-long range has another cluster of highs in the upper 1.14s too, which could also be a ceiling.

Indeed, there is even a brief spike high at 1.1713 - so should that constitute the true top of the range?

Cautious Steps Higher

One way of dealing with the problem of where the range highs are, is to take smaller cautious forecasting steps up to each potential ceiling level.

So for, example, the first step would come from a break clearly above the cluster of highs in the 1.13’s; such a move would be confirmed by a break above 1.1400, with an initial target in amongst the highs in the 1.14s – at 1.1475.

A break definitively above the 1.14s would provide more confidence that the exchange rate was in fact breaking clearly out of the range. Confirmation at that level would come from a break above 1.1550, opening the way to a longer run up to a target at 1.2000.

Finally, an eventual target might be at 1.2200 as this is the minimum target for the range breakout extrapolated using the height of the range as a guide.

This view is similar to that of Robin Wilkins at Lloyds, however, he sees 1.13 as key - expecting a break of that to lead to 1.17.

Further down the line he also envisages a probable rise to 1.20 too:

"Medium/long-term we remain trapped in a range since last March between 1.0450 and 1.1465. We expect this range to remain intact for now, with only a move through 1.1375/1.1465 risking not only a re-test of last August’s spike high to 1.17, but potentially a move towards 1.20-1.23 before the market finds renewed and significant supply."

Lloyds are however inclined to stick with the view that the recent range between 1.1350 to the top and 1.1110 at the bottom will continue to persist.

Possible Triangle Pattern

The chart below shows a triangle pattern possibly forming on the daily chart, as suggested by AFEX’s Lucy Lillicrap, who argues the consolidation is reminiscent of previous similar formations, and could see rates eventually pushing up to 1.20 - in a similar call to Wilkins: 

"Putting that into context now would infer EUR/USD tracking back toward 1.2000 even if such a rally proved ultimately corrective," says Lillicrap.

Once complete, triangles lead to breakout moves. Normally they have five constituent waves which are labelled A to E. Once E finishes the triangle usually breaks out either higher or lower. Triangles are normally continuation patterns but they can also reverse trends.

It is possible the triangle may be completing its E wave higher now, as labelled on the chart. Alternatively, it may also be finishing D before moving lower in a final E wave back down to the 1.05 range bottom. There is little to distinguish either outcome.

Unlike the weekly chart where the MFI (the pale blue line indicator shown in the lower pane) looks poised to break higher, on the daily chart the indicator looks poised to move lower, suggesting weakness in the short-term, and potentially argueing for an extension isdeways rather than a break higher near-term. 

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