EUR/USD ECB-driven weakness persists ahead of U.S. GDP

October 27, 2017 10:27 AM

The U.S. dollar will come under sharper focus this afternoon as market participants await the release of GDP. The report is expected to reveal that the world’s largest economy expanded by an annualized rate of 2.6% in the third quarter compared to 3.1% in Q2. Given the dollar’s recent upsurge, there is a possibility we may see a pullback on profit taking ahead of the publication of the data and the weekend. But if GDP beats expectations, the rally could resume as the greenback’s path of least resistance is to the upside from both technical and fundamental grounds.

Fundamentally, the dollar remains supported owing to expectations of further rate increases from the Fed, including one more before the year is out. In addition, the central bank is planning to reduce its huge balance sheet, swelled by years of bond purchases as part of its QE programm. As monetary conditions tighten in the United States, other major central banks are still keeping their policies extraordinarily loose, including the Bank of Japan, the European Central Bank, the Swiss National Bank and the Bank of England. The growing divergence of policy stances between the United States and basically the rest of the world should keep the dollar support in the long run.

Technically, the dollar Index’s breakout above the neckline of its inverted head-and-shoulders pattern around the 94.00-94.10 area is bullish. If the breakout is maintained by price holding its own above this level by the close of play this week, then we may see further dollar strength next week and possibly beyond, unless something changes fundamentally. One possible trigger for a dollar sell-off beside a potentially weaker dollar would be in U.S. President Donald Trump elects a dovish Federal Reserve head in the coming days.

As far the dollar majors are concerned, the EUR/USD is the one to watch after yesterday’s big ECB-inspired sell-off. The breakdown of long-term support in the range between 1.1660 and 1.1710 yesterday has clearly shifted the bias to the downside for the time being. A classic head-and-shoulders reversal pattern has completed as a result. While these technical indicators point lower, one has to consider the prospects of a rally.  So, going forward, from a bearish point of view, one would not like to see price move back above the now broken neckline between the 1.1660 and 1.1710 area. If it does, then we would put our short-term bearish view on hold. At this stage, we would only turn bullish in the event price breaks out of its bearish channel to the upside and clears the previous swing high at 1.1835. But if the weakness persists and prices break cleanly below 1.1615 – last year’s high – then this could clear the way for a drop to 1.1555 next, which was an old untested broken resistance level and the bottom of the bearish channel.

In short, the EUR/USD has gone from being a “buy-the-dip” market to “sell-the-rip.” It will remain that way until and unless price tells us otherwise. That’s regardless of the short-term volatility, whether driven by technical factors or fundamental events – including today’s release of U.S. GDP.

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