Fundamental Analysis

EUR/USD Key Resistance Test

EUR/USD Key Resistance Test


EUR/USD continues to struggle with resistance around the 1.1000 level, despite aggressive comments from ECB, which were reiterated in the release of the meeting minutes of the Bank’s latest rate hike.
Headline inflation CPI has continued to fall in both the U.S. and Europe, and this week eurozone inflation CPI fell to 6.9% from last week’s report US CPI of headline inflation of 5.0%. The bigger issue at the moment is core inflation, which has continued to rise in Europe, while it has softened somewhat in the U.S. recently.

The world’s most popular currency pair continues to hold near an important resistance zone with longer-term importance.

I had highlighted this resistance last month when it was about to come back into focus. Within a range of about 100 pips in the EUR/USD pair, extending from about 1.0930 to 1.1033, there are several forms of resistance that form an area of confluence. Three weeks later, this zone has bent but not yet broken through sustainably, and prices are still hovering near the bottom of this zone as of writing.

Along the way a rising wedge has built and this is a formation that’s often tracked with aim of bearish reversals, making the continued resistance test all that much more interesting as the bullish trend in the single currency and the EUR/USD pair remains in-play following a six-month rally.

But – what’s behind the move and perhaps more importantly – what might traders be looking for as that next clue as to whether this breaks out or reverses? I’ll dig deeper after this next chart.

The inflation conundrum

Ideally, central banks raise or lower interest rates in a reasonably orderly fashion. Rate hikes are particularly important in this regard because higher rates create reverberations for the rest of the world to adjust to. Even rate hikes in the U.S. can have an impact on Europe, especially if the ECB doesn’t raise rates as well, because a stronger USD and a relatively weaker euro can fuel inflation in Europe, as we saw in the first half of last year. And if interest rates rise really quickly, the impact on the underlying economy can be drastic while exposing vulnerabilities, as we saw with the recent banking sector scare in the United States, which essentially boiled down to an interest rate risk problem.

When inflation is high, the central bank has little choice but to address it, as high inflation can lead to even higher inflation, which was evident again last year in the United States. In the first half of last year, when the Fed had already begun to raise interest rates, inflation continued to rise until it finally reached 9.1% in July, the current high for the cycle CPI. At some point, the problem becomes unsustainable with only a 25 basis point increase, as the United States learned in the 1970s, and this explains why the Fed pursued such an aggressive tightening policy last June with the first 75 basis point rate hike in decades.

However, looking at the data a bit more closely and focusing instead on the core CPI, which excludes food and energy – a data point considered by both the Fed and ECB – things aren’t so clear-cut.

The core CPI index rose last month in both the U.S. and Europe. In the U.S., this was the first such increase since last October. In Europe, by contrast, the core CPI index has now risen for the 14th month in a row, and in only one case was the data point unchanged from the previous month.

So for the ECB website, the core CPI rate remains a concern, as this data point has yet to weaken. Last month, the CPI core rate in Europe surpassed that of the U.S. for the first time since February 2021, when both were at 1.4%.

EUR/USD on the rise

At this point, the fundamentals, based on both central bank hints and data, may argue for a continued strong euro. However, from the chart above, it appears that the bulls haven’t been able to push far above the 1.1000 level as there have been two different resistance levels in recent months, the most recent of which has helped to form the pattern of a rising wedge that is often followed with a bearish reversal in mind.

In such a situation, there is also the potential for a ‘topping’ scenario. This could be the case if there is a breakout that brings a new high with a test of the 1.1100 level or higher, followed by a quick reversal. This is similar to what happened on February 2 with the 1.1000 and 1.1033 levels in EUR/USD. The big question for the trend continuation is whether buyers can be found to support a new high, or whether a rise to a new resistance level will bring enough sellers to the table to ultimately change the shape of the trend.

A shorter-term look at EUR/USD and the 1.0909 level remains crucial for short-term strategies, as this is the recent high-low. Should the pair break below it, the support side of the rising wedge would also be tested, further opening the door for reversal.