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Can ECB's Draghi Stop The EUR/USD From Breaking Out?


The EUR/USD currency pair continued to retreat on Tuesday, to close at $1.1143 per euro, after European Central Bank (ECB) president Mario Draghi said during a hearing on Monday, in front of the European Parliament's Economic and Monetary Affairs Committee in Brussels, that the ECB won't hesitate to boost its stimulus in March if it believes recent financial-market turmoil or lower oil prices could further weigh on eurozone inflation.

The ECB remains concerned about crude oil prices and inflation, as Draghi put it at a news conference after the Governing Council meeting of the ECB in Frankfurt on January 21 that, "On the basis of current oil futures prices, which are well below the level observed a few weeks ago, the expected path of annual HICP inflation in 2016 is now significantly lower compared with the outlook in early December,". "Inflation rates are currently expected to remain at very low or negative levels in the coming months and to pick up only later in 2016.", said Draghi.

Mr. Draghi may not have many options, either act soon or face the consequences of a rising euro against the U.S. dollar. Nearly 68% of economists surveyed by Bloomberg now say that the Fed's next rate hike will be at the Federal Open Market Committee (FOMC) meeting in June. In January, only 30% of those surveyed had thought that the Fed would increase in June, with the majority believing in a March rate hike.

According to MarketWatch, Mr. Patrick Harker, Federal Reserve Bank of Philadelphia President, said in a speech on Tuesday at the University of Delaware that inflation could be negative in the first-quarter and Fed policy should be able to "truly normalize" in the second-half of the year, with steady growth, a low unemployment rate and price pressures starting "to assert themselves".

As of February 9, there are 118,095 short positions of euro FX, traded on the Chicago Mercantile Exchange, CME, by leveraged funds, a week-over-week decrease of 1,454 short positions. This is compared to about 56,296 long positions, up 11,300 from the previous week, according to the Commitment of Traders, COT, data released by the Commodity Futures Trading Commission, CFTC.

For the week ending December 1, there were as many as 197,721 short positions of euro FX and only 40,995 long positions, where euro FX contracts are traded in units of 125,000 euros. The data suggests that in less than two months after the Fed rate hike, hedge funds have cut their short positions almost in half, while adding about 30% more to their long positions, as they are becoming increasingly bullish on the euro.

During the last Federal Reserve rate hike cycle, from June 30, 2004 when Fed Chair Alan Greenspan started hiking the fed funds rate to 1.25% from 1.0%, a then historic-low, through June 29, 2006, when Fed Chair Ben Bernanke raised the Fed funds rate for the last time to 5.25% from 5.0%, the EUR/USD increased just 3.82% from $1.1164 per euro to $1.2659 per euro in the 2-year period, trading in a range between $1.164 per euro and $1.367 per euro.

Things may be different this time around as the EUR/USD has already gained 3.18%, to $1.1252 per euro on February 16 from $1.0905 per euro, since the Fed announced a quarter-point hike in interest rates on December 16.

Wall Street's forex currency strategists are backtracking on their call for euro-dollar parity. According to The Wall Street Journal, Goldman's chief FX strategist Robin Brooks wrote in a note in December that the bank now sees the euro at $1.07, $1.05 and $1.00 in 3-, 6- and 12 months, respectively. Previous forecasts for those time horizons had been $1.02, $1.00 and $0.95. Goldman Sachs had said in March that the euro would hit parity with the dollar by September.

Technically, the EUR/USD currency pair has been trading in symmetrical triangle chart patterns, between the $1.046 and $1.14 per euro levels. A double bottom, at $1.046 and $1.054, has emerged and the currency pair is about to break out. The hedge funds are now cutting back their short positions and adding more to their long positions, meaning they are expecting the EUR/USD to move higher near-term.

EUR/USD Technical Chart

From our technical viewpoint, the currency pair could break out and continue to move higher to the $1.30 per euro level, or the upper trendline resistance of the symmetrical triangle chart pattern, unless Mario Draghi makes a move.

Mr. Draghi may be stuck between a rock and a hard place, as the German Constitutional Court is considering legal objections to ECB Outright Monetary Transactions, OMT, a scheme launched in 2012 during the eurozone debt crisis, but not yet used. According to the BBC, the German Court's ruling, not expected for months, could have an impact on the current ECB bond-buying program.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.