Article / 07 April 2017 at 2:02 GMT

History may repeat itself, as chart signals EURUSD is on the way down

Managing Director / Technical Research Limited
New Zealand
  • A pattern from 1997-1999 may be about to repeat itself for EURUSD
  • EURUSD could decline even if rate differentials move in its favour
  • European election risk looks like a potential driver for the currency pair
  • Traders have noticed the recent low inflation reading and dovish ECB rhetoric
By Max McKegg

The demise of the euro has been predicted by many analysts over recent times, usually centred around EURUSD breaking through parity and then gathering momentum en route to its 2001 low at around 0.8200. But for some time, the cross has been in a sideways pattern, defying bulls and bears alike. Many trend-following traders put have it in the too hard basket and looked elsewhere.

Not as easily put off, the analysts at CitiFX, the world’s largest FX trader, have concluded the recent chart pattern looks remarkably similar to the 1997-1999 formation, suggesting, if history repeats, this is an excellent selling opportunity in EURUSD. Citi sold at 1.09 and recommended clients join them. This chart illustrates how they see the trade evolving over the coming months.

 Source: CitiFX

The team at Citi don’t confine themselves to technical analysis. Having spotted what looks like a repeating pattern they go back and have a look at what the prevailing “fundamentals” were at the earlier date. You would have thought they discovered a widening interest rate differential in favour of the USD which, in turn, was driving EURUSD lower.

 Political risk, including fears of a victory by the Eurosceptic, far right presidential candidate Marine Le Pen in France, could be drive the euro lower. Photo: Shutterstock

In fact the opposite was the case, because in late 1999 the European Central Bank had found itself behind the curve and reversed course, tightening monetary policy. At the same time the Federal Reserve was on its own path to higher rates.

Today we see calls for the ECB to reverse course while the Fed is well under way with its rate “normalisation” strategy.

The takeaway from the fundamental comparison is that the policy change by the ECB sent the EURUSD down, not up as might have been expected.

Is this a case of deja vu then ?

At this stage of proceedings the ECB is giving no hints they intend to change course any time soon. The bank’s chief economist and governing council member Peter Praet said in a recent interview that he is more optimistic about the economic outlook, but on going expansionary monetary policy was needed to achieve the inflation target.“If the markets were to pick up any change in communication about the deposit rate” he said” it would have the potential to change the policy stance, and we do not want that to happen right now”.

Other governing council members, including President Mario Draghi, are singing from the same song sheet, letting the markets know they see no sign of much improvement in the outlook for core inflation. In fact, the minutes of the council’s March meeting show some concern about whether the central bank’s current inflation assumptions are still valid. As the following chart shows, core inflation dropped to an annual rate of 0.7% last month, raising doubts about the 1.1% average expected for 2017

ECB inflation chart

Market based inflation expectations data is not moving in the right direction either, with the 5 year/5 year forward break even rate drifting down. The jury is still out on how much impact the recent oil price decline is having on this calculation but the ECB won’t be giving it the benefit of the doubt.

5 year/5 year rates chart

Source: Goldman Sachs, J B Were

Traders have taken note of the recent low inflation reading and the ECB’s dovish rhetoric. The probability of a rate hike this year has dropped from over 50% to around 15%. Clearly then, short dated rate differentials will be working against EURUSD for a while yet.

Eonia rate hike probability chart


 Source: The Daily Shot

When there are lulls in the economic data calendar and the political situation across the Eurozone is calm, EURUSD traders often take their cue from the 10-year US Treasury versus German bund yield spread. At over 2% it remains at its highest level since peaking just under that mark in 1999. But, as CitiFX points out, despite the spread in favour of the US then narrowing for the next three years, EURUSD declined with it. Theoretically it should have gone up.

A similar situation may be developing now. The main impact of the ECB’s bond buying program is on the short to medium part of the German bund curve while longer term rates drift up as shown in the following chart. The curve is changing shape. Meanwhile yields in the US bond market remain stuck in a range. So, as in 1999, the 10-year spread may have peaked and, while counterintuitive, history suggests this will not necessarily benefit the euro.

German Bund yields

Source: Allanz Global Markets

If EURUSD is going to repeat the 1999 chart pattern and sell off from here, even as medium term rate differentials move in its favour, what outside factor will be the driving force? The obvious one is political risk, with elections in both France and Germany on the agenda. Others on Trading Floor are better qualified than me to discuss the possible scenarios in that arena. Instead, I will leave readers to ponder the chart from CitiFX that suggests, for whatever reason, history may be about to repeat for EURUSD.

My trading forecast on EURUSD is based on last week’s striking “Outside Reversal Week” and my Elliott Wave analysis (see weekly chart below)

Weekly EURUSD Chart
Source:  ThomsonReuters

For more on forex, click here.

– Edited by Robert Ryan

Max McKegg is managing director of Technical Research Limited. Follow Max here or post your comment below to engage with Saxo Bank's social trading platform
bfmalay bfmalay
Very interesting article Max, Thanks you for sharing. Do you think it will really reach 1.09 before the drop?
Treve Treve
Max my company receives this Citi FX research. It always reads impressively but seldom works out. Their long term track record is abysmal !
Patto Patto
I think George Soros has been crying Wolf ! on the euro for years.and it must have cost him. So far so good with this trade of Citi's but let's what happens later on today when the US jobs numbers come out......
Max McKegg Max McKegg
well said Patto
Max McKegg Max McKegg
Treve, Citi certainly have enough $resources and staff so should be performing at a high level.
Allied Allied
I'm with Treve on the Citi research on FX (my ex shop). I keep a track record on all recommendations from all the research I get and you would be down a small fortune if you followed all the Citi trade ideas. I'm bearish EURUSD from a macro view but I can't see what it is yet that's going to break this range and move it lower.
Max McKegg Max McKegg
Not Good!
Ekwueme Mike Anyadibe Ekwueme Mike Anyadibe
Interesting Elliot wave numbering/labeling on EUR/USD....what an alternative count....i am bearish with You though...


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