Chart Of The Day: Euro To Resume Slide Below Parity

Fundamentals

While Eurozone inflation surged to US levels, the euro has three primary disadvantages versus the dollar:

• Interest rate differentials
• Recession
• Ukraine conflict

Interest Rate Differentials

The ECB surprised markets on July 21 with a 0.5 percentage point rise in its first increase in 11 years—to the whopping rate of...0%. The Federal Reserve raised on July 27 its second 0.75% hike in a row to over 2%. It does not look like the ECB will be able to catch up with the Fed rate soon.

Eurozone unemployment is 6.6%, nearly double the 3.5% in the U.S. Much higher unemployment leaves the ECB that much less room compared to the Fed to raise rates because of fears it will exacerbate unemployment.

Recession

Weak economic data this week strengthened the opinion that we are already in or heading toward a downturn, so the US dollar firmed. The currency is a natural haven for countries and companies facing currency uncertainty as it is the world's reserve currency and the denomination for many international business deals.

But, wait, doesn't a recession invalidate that?

First, there are still massive positive interest rate differentials for the dollar.

Second, inflation and recession are not mutually exclusive. An economy can experience a recession and inflation simultaneously—stagflation. Many economists have warned about this phenomenon, which was last seen in the 1970s. However, stagflation requires unemployment, which the Biden administration doesn't think is likely. But, there have already been some hiring freezes and even downsizing to cut costs in preparation of economic tightening, and if this trend resumes, we could have increased unemployment.

The dangers of a stagflating economy are that it distorts businesses' investment decisions, and for consumers, it means that they may be unemployed or earning less while prices for everything are rising. So, they consume less, which hurts companies and causes a vicious cycle of unemployment and lower wages.

Ukraine

The Russian invasion of Ukraine directly impacts the euro area's economy. The European Central Bank said that beyond the "observable factors affecting economic activity" of "very high energy prices" and "renewed supply shortages," there are also unobservable factors from the associated rise in uncertainty shock.

Technicals

The supply-demand balance has favored the dollar for a long time. Here are just a couple of recent examples. On March 16, I forecast an eventual target of 0.84, the 2001 lows. Two months later, on May 16, I predicted that the euro would head to parity and even lower.

Now, let's get an update on what the forces of supply and demand are up to.

EUR/USD Daily

The EUR/USD completed a Head & Shoulders continuation pattern between early May and early June. Based on its height, its implied target was 424 pips. After reaching 414 pips, the pair bounced. However, after a three-day rally, the pair was congested. Bulls kept raising their bids, but sellers disagreed that the trend should rise, as they kept their offers suppressed. Here are the bids vs. offers:

1. The July 7 to 21 highs rose 0.56% Vs. the July 14 to August 3 low of 3.99%.
2. The July 21 to the August 11 climb gained 0.85%. I don't have another low to measure the second difference in troughs, as the price didn't bounce yet. However, if we use the current pricing as a low, then from the August 3 trough to today is 0.46%

The psychology of the pattern is that bulls are losing patience with their lack of progress and will exit positions, leaving the bears in charge. Note that despite the price's advance, the Rate of Change, measuring changes in momentum, dropped, providing a negative divergence. In other words, this indicator shows that despite the apparent price advance, it's been losing momentum. Furthermore, the ROC just fell below its previous low, completing a descending series of peaks and troughs, as it appears to be topping.

Because of these reasons, I believe that the EUR/USD will continue along its falling channel since the beginning of the year, with its first target being the wedge's low, at 0.9952. Then, it could resume along my May 16 forecast of continuing its fall toward its 2001 lows.

Trading Strategies

Conservative traders should wait for the price to complete a return move to confirm the wedge's resistance before considering risking a short.

Moderate traders could feel comfortable committing to a short when the price triggers a return move to reduce exposure, if not to confirm the downtrend.

Aggressive traders can enter a long contrarian position, counting on a return move off the lows, going back almost a month before they join the rest of the market in a short. This is a risky position, making a coherent trade plan all the more crucial. Therefore, work according to a trading plan incorporating your timing, budget, and temperament. Until then, you can use the following generic sample for practice:

Trade Sample 1 - Aggressive Long Position:

• Entry: 1.0125
• Stop-Loss: 1.0100
• Risk: 25 pips
• Target: 1.0225
• Reward: 100 pips
• Risk-Reward: 4

Trade Sample 2 - Moderate Short Position

• Entry: 1.0250
• Stop-Loss: 1.0350
• Risk: 100 pips
• Target: 0.9950
• Reward: 300 pips
• Risk-Reward Ratio: 1:3

Disclaimer: The author currently does not own any of the securities mentioned in this article.