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Chart Of The Day: Euro Set To Retest All-Time Lows On Inflation Differentials

Chart Of The Day: Euro Set To Retest All-Time Lows On Inflation Differentials

As we write this, WTI is trading above $75 for the fourth straight day. In fact, it’s more than halfway toward $77, its highest level since Nov. 12, 2014. The breakdown of production limit talks among the OPEC+ nations has sent crude climbing toward $80 a barrel.

But wait, readers might be saying to themselves at this point, didn’t the headline indicate this post would be about the euro? Indeed, and yes, it is.

The current sharp rise in the price of US oil may have a significant impact on the US dollar, for two reasons.

First, the obvious: since oil is generally denominated in USD, and the United States is the largest exporter of the commodity in the world, crude prices will become more expensive, boosting demand for dollars with which to pay for the more expensive oil.

And that will pressure Europe, which isn’t even among the top 10 producers. The UK, which deals in Brent, is the 13th largest producer, it’s not part of the EMU, and never was, having kept its pound sterling as the sovereign currency.

Second, the surge in oil prices will likely have a substantial impact on inflation. Gas prices are already on the rise as the summer driving season kicks off and international travel starts to increase, on pent-up travel demands after a year-and-a-half of social restrictions.

Though the Federal Reserve has been trying to downplay inflation, there’s a limit to how much the central bank can control the overall situation. And the last thing the Fed wants is to chase inflation in order to curb it, by being forced to raise interest rates more rapidly and more aggressively than anticipated. 

But if oil prices—which are now predicted to return to $100—continue rising, the US central bank could be forced to move up both its timeline and number of hikes beyond levels previously discussed, which had already shocked the market.

On the other hand, as ECB President Christine Lagarde told the European Parliament in June, “the United States and Europe are clearly in different situations,” since the US recovery was far ahead of the eurozone’s. Lagarde underscored that it was premature to raise rates, so the EU central bank would maintain favorable financing conditions. Will out of control oil prices give the Fed the same luxury?

We can’t know, of course, but the balance of supply and demand for the EUR/USD pair could provide some insight into what FX markets think.

After nearing a rising flag, the euro turned an advance into a decline, since the flag was bearish after the 2% plunge in just three days that preceded it. The current advance could be a throwback, which affords traders an opportunity to limit exposure, as well as confirm the downtrend.

The price cut through the 200 DMA and even confirmed its resistance on the following day. Notice how the candle produced an upper shadow, but the moving average rejected the price, pushing it lower. Both the 50 and 100 DMAs are falling toward the 200 DMA. Here’s why:

Chart Of The Day: Euro Set To Retest All-Time Lows On Inflation Differentials
EUR/USD Weekly

The currency pair is on the verge of completing a massive H&S Top since mid-2020. The price fell below the 50-weekly MA, then tried to climb back above it. As with the daily 200 DMA, the price went above it during the candle’s development but couldn’t maintain gains and closed below it.

During the following week, it wiped out the previous week’s gains, which were the result of the failed effort to overcome the moving average.

Both the MACD and the RSI Provided negative divergences, falling against the rising price. Both show distinct aspects of the trade.

The MACD demonstrates that within a broad spectrum of prices, smoothed out by averages, recent pricing has gotten weaker. The RSI reveals a weakness in the previous rising price, a slowing momentum. True to form, the price fell from its January highs almost down to its November low, forming the head.

Then, the situation got worse, when the next rally peaked in May, but lower than the previous high, forming the right shoulder. What remains is for the price to decisively fall below the neckline, the price connecting the pattern’s lows, in order to be called as a top.

But there’s still more to consider. Take a look next at the monthly chart.

Chart Of The Day: Euro Set To Retest All-Time Lows On Inflation Differentials
EUR/USD Monthly

It becomes visible that the “massive” weekly H&S top is potentially just a part of the right shoulder of a much, much larger H&S, but of the continuation persuasion, following the single currency’s loss of a quarter of its value, most of which occurred in just one year, when the currency pair dropped below the 200-monthly MA.

Now, for one final chart (we promise!), which shows the full picture.

Chart Of The Day: Euro Set To Retest All-Time Lows On Inflation Differentials
EUR/USD Monthly, 1982-2021

Via this view it’s obvious there’s an even more-massive H&S, in place since 2015. It’s actually the downside breakout and return-move that followed a decade-long H&S pattern, from 2004 through 2014. Notice how the 200 monthly MA harmoniously fits in the chart, forming the neckline for the 10-year-long pattern, as well as providing the resistance that sets into motion the H&S continuation pattern, starting in 2015.

The last time there was a H&S on a similar scale was between mid-1986 and the beginning of 1997. It forshadowed the common currency losing 30% of value in the following 3.5 years.

Will the completion of the current daily H&S top bring about the completion of the weekly H&S continuation pattern that would break the rising channel—whose bottom is the natural neckline of the H&S continuation pattern since 2015? Stay tuned.

Trading Strategies

Conservative traders should wait for the price to break the neckline of the daily H&S top, to avoid a rebound. They should then wait for the price to rally and find resistance by the broken neckline.

Moderate traders would wait for the same decline below the neckline and preferably for a corrective rally, to reduce exposure, if not test for resistance.

Aggressive traders could short now, counting on the flag. However, they should consider that the breakout is already mid-move and can whipsaw, especially considering tomorrow’s release of the FOMC minutes. Whatever they do should only be done according to a plan whose reward justifies the risk. Here’s an example:

Trade Sample

  • Entry: 1.1875
  • Stop-Loss: 1.1900
  • Risk: 25 pips
  • Target: 1.1800
  • Reward: 75 pips
  • Risk:Reward Ratio: 1:3

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