Sunday, March 2, 2014

Euro is at a multi-year decision point | Sterling resistance turns into support

The Euro is attempting to go above the level of 1.38 to the US dollar, which it also tried to do, without success, on a number of occasions last year. The last time the pair traded above 1.38 was back at the end of 2011, over two years ago. All of this makes 1.38 a significant resistance.

So we have to ask: What might cause it to break out from here to the upside? The most likely answer will probably have to do with the attitude of the European Central Bank to the threat of deflation. This is something of which they are in dire dread. The Eurozone CPI (Consumer Price Index, a measure of inflation) was at 0.8% last week. This marked an ever-so-small increase on the previous reading, but it was an increase, and this reduces the possibility that M. Draghi and his colleagues will enact extraordinary measures later this week to increase inflation to at or close to the 2% level that they regard as ideal. Any such move would tend to weaken the Euro.

The Single Currency has proven to be resilient in the past. Even a reduction in the base lending rate was shrugged off by the market when it was enacted last November.

The other side of the EURUSD equation is, of course, the US dollar. The excuse that has been used for weaker than expected US economic indicators, extreme weather conditions Stateside, has been given so often now that it is grown a little thin, which means that anything other than a really dramatic increase in Non Farm Payrolls, which are due out on Friday, will be bad for the Greenback.

Resistance turns to support for Sterling

In a classic, text-book example of how support and resistance often plays out, the strong and long-standing resistance we have highlighted in the case of the British pound / US dollar pair (GBPUSD), also known as “Cable” because of the fact that this instrument was the very first one to be used for electronic currency exchange, back in the days when such activity depended on an undersea cable across the Atlantic, has now turned into support. This can be seen on the daily chart above, which we have marked with the current level of the monthly 200-period SMA, which is the resistance level in question, as discussed in past commentaries.

The mechanism behind this phenomenon has to do with market psychology. Traders have memories and the collective effect of decisions that were made in response to technical analysis indicators in the past influence current position placement. The end result of this is that former resistance often turns into support and former support, on the way down, can turn into resistance. In those cases where the support or resistance holds (in other words the transformation of one into the other is not sustained), double tops and bottoms, well respected price patterns in themselves, come into being.

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