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EUR/USD Outlook Mired by Head-and-Shoulders Formation

EUR/USD Outlook Mired by Head-and-Shoulders Formation

David Song, Strategist

Sign Up & Join DailyFX Currency Analyst David Song to Discuss Key FX Themes & Potential Trade Setups.

The fresh developments coming out of the European Central Bank (ECB) may alter the near-term outlook for EUR/USD as President Mario Draghi and Co. appear to be on course the wind down the quantitative easing (QE) program.

Even though the Governing Council remains in no rush to remove the zero-interest rate policy (ZIRP), it seems as though the central bank will continue to drop its dovish tone and gradually alter the course for monetary policy as ‘the continued strong momentum of the euro area economy supported confidence that inflation would gradually reach levels in line with the ECB’s medium-term objective.’ With that said, a material reduction from the current EUR 60B/month pace may heighten the appeal of the single-currency especially if the ECB lays out detailed exit strategy.

However, EUR/USD may face a more bearish scenario should the Governing Council vote in favor of extending the QE program beyond the December deadline. President Draghi and Co. may stress that ‘the net purchases would be made alongside reinvestments of the principal payments from maturing securities purchased under the asset purchase programme’ as the central bank struggles to achieve its primary mandate for price stability, and the fresh updates coming out of the Governing Council may trigger a more meaningful correction in EUR/USD as a head-and-shoulders formation takes shape.

EUR/USD Daily Chart

EUR/USD Daily Chart

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Even though EUR/USD preserves the monthly range, the near-term outlook remains tilted to the downside as the pair remains capped around 1.1860 (161.8% expansion), with both price and the Relative Strength Index (RSI) still retaining the bearish formations carried over from August. If EUR/USD is in the process of completing the right-shoulder, EUR/USD stands at risk of giving back the rebound from the monthly-low (1.1669), with a break/close below the 1.1670 (50% retracement) hurdle opening up the next downside region of interest around 1.1580 (100% expansion).

However, a bullish reaction may negate the threat for a near-term reversal in EUR/USD, with a break/close above the 1.1860 (161.8% expansion) region raising the risk for a move back towards 1.1960 (38.2% retracement).

EUR/USD Retail Sentiment

EUR/USD Retail Sentiment

See how shifts in EUR/USD retail positioning are impacting trend- Click here to learn more about sentiment!

Retail trader data shows 36.1% of traders are net-long EUR/USD with the ratio of traders short to long at 1.77 to 1.

The number of traders net-long is 19.1% lower than yesterday and 22.4% lower from last week, while the number of traders net-short is 0.9% lower than yesterday and 3.7% lower from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EUR/USD prices may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EUR/USD-bullish contrarian trading bias.

--- Written by David Song, Currency Analyst

To contact David, e-mail Follow me on Twitter at @DavidJSong.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.