Never miss a story from Christopher Vecchio

Subscribe to receive daily updates on publications
Please enter valid First Name
Please fill out this field.
Please enter valid Last Name
Please fill out this field.
Please enter valid email
Please fill out this field.
Please select a country

I’d like to receive information from DailyFX and IG about trading opportunities and their products and services via email.

Please fill out this field.

Your Forecast Is Headed to Your Inbox

But don't just read our analysis - put it to the rest. Your forecast comes with a free demo account from our provider, IG, so you can try out trading with zero risk.

Your demo is preloaded with £10,000 virtual funds, which you can use to trade over 10,000 live global markets.

We'll email you login details shortly.

Learn More about Your Demo

You are subscribed to Christopher Vecchio

You can manage your subscriptions by following the link in the footer of each email you will receive

An error occurred submitting your form.
Please try again later.

Want to learn more about the DailyFX SSI indicator? Click here to watch a tutorial.

2016 started with a ‘whimper' for EUR/USD, but as we head into Q4’16, it may very-well end with a ‘bang.’ Weathering a number of thematic storms over the summer - the Brexit vote fallout and speculation around the timing of the Fed’s first rate hike - EUR/USD was surprisingly docile in the last few weeks of Q3’16. Given the sheer number of significant events that are due to pass over the last three months of 2016, the low volatility experienced for stretches during last quarter is unlikely to persist to the same degree.

On the Euro side, there are several drivers to look out for, but most point in the same direction: the next round of easing by the European Central Bank. Primarily, it seems that markets are currently underpricing the odds of another rate cut this year, given the political backdrop in the European Union.

At the Jackson Hole Economic Policy Symposium, European Central Bank Executive Board member Benoit Coeure said “If other actors do not take the necessary measures in their policy domains, we may need to dive deeper into our operational framework and strategy to do so.” The actors he speaks of are elected officials; unfortunately, they are hamstrung the next several months.

Italian Prime Minister Matteo Renzi faces a constitutional referendum in December, which if succeeds, should unclog Italy’s fractured political system; he’s out of the game for most of Q4’16. German Chancellor Angela Merkel and French President Francois Hollande face the same issue: elections around the corner in 2017. With both leaders fading in the polls (although, how much further can Hollande really fall at this point? to 0% approval?), they will likely be forced to pivot to appease upstart anti-EU, anti-immigration parties; increasing stimulus in the name of the pan-European project would be politically costly at present time and thus is unlikely to be pursued at all.

Accordingly, the political appetite for stimulus in the major Euro-Zone countries is stagnant for Q4’16, which means that, if we believe ECB Executive Board member Couere, then the ECB will be forced to stimulate markets, simply by default for being the only game in town. Thus, given current pricing, markets are probably underestimating the likelihood of more action by the end of 2016.

A few days before the start of Q4’16, overnight index swaps were pricing around a 20% chance of a 10-bps rate cut by the December meeting. Another rate cut, if it were to happen this year, makes sense for December (rather than October). The ECB, like the Federal Reserve, has fallen into the habit of only changing policy when it has new growth and inflation projections in hands to justify the shift; the next update is December.

One item on the docket for the ECB to tackle during Q4’16 will be its review of its QE program. At the September ECB policy meeting, ECB President Mario Draghi announced that a committee would undertake an examination of the effectiveness of the QE program. Reading the tea leaves, it seems that Draghi & co. are more concerned with ensuring the QE program is working properly rather than seeking to expand it.

Along these lines, the ECB is undertaking the review of its QE program due to the constraints posed by the -0.40% deposit rate threshold and the capital key ratio. The ECB will very likely be forced to remove the -0.40% barrier (allowing more German bunds to be purchased), or to remove the capital key restriction (allowing more peripheral sovereign debt to be purchased).

For the US Dollar, there are two big influences in Q4’16, but they mind as well be one in the same: the US Presidential elections and the Federal Reserve’s December policy meeting. Given the immense disparity in policy positions outlined by Democratic candidate Hillary Clinton (seen as a ‘continuation’ of current policies) and Republican candidate Donald Trump (seen as a ‘disruption’ of current policies), Fed officials are likely to want to wait to see the results of the election.

Put simply, unless there is a seismic shift in the US political environment, the Fed will be forced to go back to the drawing board and dramatically alter its growth and inflation forecasts. Doing so will possibly come at the expense of a rate hike this year - which means one less reason to like the greenback. There are thus two periods to watch for on the US Dollar side: the run-up to the election on November 8; then the fallout and lead-in to the December 14 FOMC meeting. Even though EUR/USD is coiling now, there are plenty of reasons to look for increased volatility.

Technicals: EUR/USD in the Midst of a Historically Impressive Coil

EUR/USD Coil Grows Tighter as Central Banks, Politicians Face Credibility Deficit

EURUSD Weekly Chart - Created by Jamie Saettele, Senior Technical Strategist with Trading View Charts on DailyFX.com

The Q3’16 EUR/USD range (3.53%) was the smallest quarterly range since Q2’07 (3.30%). The Q2’07 quiet period preceded a nearly 3,000 pip rally over the coming three quarters. The ranges in Q1 and Q2’14 (both 3.65%) were slightly larger. That quiet period preceded a nearly 3,000 pip decline in three quarters. While the moves following both quiet periods were around the same big figures, the point is, these really quiet periods tend to resolve with a bang. The coiling in EUR/USD is the calm before the storm if you will.

Our technical analysis from last quarter made the case for a longer-term trend change (higher) based on fifteen-year intervals. “The highs in 1980 and 1995 separate by 15 years as do the lows in 1985, 2000, and 2015. The outlier is the 2008 high.” We also wrote “A weekly close above $1.1450 would warrant action in EUR/USD and set the stage for a run at $1.3000 in short order. If the March 2015 lows break, then the call for a bottom is wrong and focus would shift to $0.9450-.9550 (historical inflection point and measured objective).” There is no change to this analysis other than noting that the breakout level can be lowered to the Q3’16 high of $1.1366. With little to add in terms of outlook, we’ll present something different this quarter as EUR/USD is in the midst of a historical period of consolidation.

Just how coiled is EUR/USD? We can make the case that it’s the most coiled in history! Generally speaking, the length (in time) and width (in price) of consolidation phases is proportional to the strength of the resulting trending move. Markets are not governed by the laws of physics, but there is a useful analogy to draw upon: technicians can view consolidation length as potential energy; and the resulting trend breakout as kinetic energy (energy in motion) is fitting.

There are myriad ways to measure consolidation but our favorite way is to simply count the number of periods between fixed length price extremes. The chart above displays the number of weeks without making a new 52-week high or low (on a closing basis). So, how much stored potential energy is there in EUR/USD right now? The most ever, according to the measure described! It’s been 81 weeks since the last 52-week high or low. The previous record was 77-weeks, which ended with the breakout in May 2002 (highlighted). A 52-week low wasn’t tested for another 239 weeks!

The only longer sideways period for a major was an AUD/USD consolidation that measured 94 weeks and ended in May 2013. Price has yet to make a 52-week closing high (267 weeks and going) since that break. The data for this study is based on weekly closing prices since 1972. Indeed, 2016 may have started with a ‘whimper’ for EUR/USD, but the odds of it closing with a ‘bang’ are going up significantly.

Disclaimer

DailyFX Market Opinions

Any opinions, news, research, analyses, prices, or other information contained in this report is provided as general market commentary, and does not constitute investment advice. DailyFX will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on such information.

Accuracy of Information

The content in this report is subject to change at any time without notice, and is provided for the sole purpose of assisting traders to make independent investment decisions. DailyFX has taken reasonable measures to ensure the accuracy of the information in the report, however, does not guarantee its accuracy, and will not accept liability for any loss or damage which may arise directly or indirectly from the content or your inability to access the website, for any delay in or failure of the transmission or the receipt of any instruction or notifications sent through this website.

Distribution

This report is not intended for distribution, or use by, any person in any country where such distribution or use would be contrary to local law or regulation. None of the services or investments referred to in this report are available to persons residing in any country where the provision of such services or investments would be contrary to local law or regulation. It is the responsibility of visitors to this website to ascertain the terms of and comply with any local law or regulation to which they are subject.

High Risk Investment

Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain losses in excess of your initial investment. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.