EURUSD breaks out from falling wedge, but is not out of the woods yet

18 May 2022

Since the start of 2022, the EURUSD currency pair has depreciated around 7.5% due to the strong US Dollar, which also strengthened against many other currencies. Last Thursday on 12 May 2022, the pair dipped to a lowest point since January 2017, at 1.0350, before rebounding to hover around 1.0500. The US Dollar Index (DXY), which gauges the greenback’s strength against a basket of rival currencies, remains near the highest levels since January 2017, around 103.7.

Safe haven status sends the US Dollar on a strong uptrend

The strength of the US Dollar is due to several factors, with market risk sentiments playing a significant role. Amid the ongoing uncertainty around the war in Ukraine, and lockdowns in China, the US Dollar benefitted from its safe haven status. In a risk-off (risk averse) market, there is a tendency for funds to rotate from riskier assets like stocks and cryptocurrencies, into safer assets like the US Dollar denominated bonds.

With the heightened demand for the safe haven currency, the value of the US Dollar increased in relative to other currencies.

Hawkish ECB provides support for the Euro

The recent rebound in the EURUSD pair may be an effect of the increasingly hawkish expectations on the European Central Bank’s (ECB) monetary policy decision in July.

The euro zone inflation which soared to a record high of 7.5% last month, which is well above the ECB’s target of just 2%, has led policymakers advocating a rapid unwinding of stimuli, with some members asking for a rate hike as soon as July. One of the more hawkish ECB members, the Dutch central bank chief Klaas Knot, raised the prospect of a half percentage point interest rate increase in July, if inflation continues to climb, marking the first time such an aggressive shift has been discussed.

Technical Analysis

Looking at the daily chart, EURUSD has broken out of a falling wedge formation, which typically signals a bullish trend reversal. This is also in line with a bullish divergence observed on the Relative Strength Index (RSI), where prices create lower lows while the RSI reading logs higher lows. The Moving Average Convergence Divergence (MACD) indicator is in the bearish zone with the histogram below zero. However, the bearish momentum may be waning with the histogram inching above the signal line.

Despite the short-term rebound, EURUSD on the weekly chart remains largely in a downtrend. Several resistance levels the pair has to break above to validate further upsides are 1.0636 (R1), and 1.0808 (R2) in extension. If EURUSD finds support above these levels, traders could anticipate a price target at 1.1016 (R3). In the alternate scenario where the rally is not sustained, S1 at 1.0379 is an important support level to hold to validate the bullish trend reversal.

Wednesday, May 18

EUR – HICP (MoM)(Apr), HICP-X F,E,A,T (MoM)(YoY)(Apr)

USD – Building Permits (MoM)(Apr), Housing Starts (MoM)(Apr)

Thursday, May 19

EUR – ECB Monetary Policy Meeting Accounts, ECB’s De Guindos speech

USD – Initial Jobless Claims (May 13), Philadelphia Fed Manufacturing Survey(May), ECB’s De Guindos speech

Friday, May 20

EUR – ECB’s Lane speech, Consumer Confidence (May)

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