EUR/USD Forms Massive Head and Shoulders Pattern ahead of ECB

The EUR/USD rose for the first time in six days as investors waited for the important US inflation data and European Central Bank (ECB) decision set for Thursday.

Euro bounces back

The EUR/USD price has been on a steep downward trend in the past few weeks as investors focus on the $1.9 trillion stimulus package and its impact on the American economy. The pair has dropped by almost 4% from the year-to-date high of 1.2325. 

The record stimulus has pushed many investors to assume that the economy will overheat and force the Federal Reserve to change its relatively dovish tone. In this, the bank could start talking about a gradual increase of interest rates and tapering of interest rates.

The Fed is in a difficult place. On Friday, data showed that the US unemployment rate is at 6.2%, which is significantly higher than the pre-pandemic low of 3.8%. At the same time, consumer inflation in the US is rising. In January, the headline consumer inflation rose by 1.4%, helped by the large stimulus package that was implemented in January. 

The Bureau of Statistics will publish the February inflation numbers. Economists polled by Bloomberg believe that the headline consumer price index (CPI) increased by 1.7% in February as the economic recovery continued. If they are right, it means that inflation has moved from less than 0.5% last year to almost 2%. 

Therefore, the Fed will be pressured because it has to decide on whether to increase interest rates to tame runaway inflation or continue with the current monetary policy to help reduce the unemployment rate. In 2020, Jerome Powell said that the bank will prefer allowing inflation to run above 2% for a while.

However, the market seems to be suggesting that the Fed will increase interest rates. As shown below, the ongoing bond sell-off has pushed bond yields to their highest level in more than a year. As a result, the US dollar has rallied while stocks have retreated. On Tuesday, however, the bond market cooled as investors waited for the US inflation data.

ECB decision

Across the Atlantic, the European Central Bank is set to start its two-day meeting on Wednesday. In it, they will deliberate the recent performance of the Treasuries market and the ongoing recovery of the European economy.

Still, analysts believe that the meeting will not have a different outcome from the previous ones. Instead, the bank will leave interest rates and the pandemic emergency purchases (PEPP) or quantitative easing policies unchanged. Furthermore, they have helped accelerate the recovery of the Eurozone’s economy.

On Tuesday, the EUR/USD also rose after the mixed economic data from Europe. Numbers by the German statistics agency showed that the country’s exports increased from 0.4% in December to 1.4% in January. This increase was better than the median estimate of a 1.2% decline. In the same period, the country’s imports declined by 4.7%, leading to a trade surplus of more than 22.2 billion euros. Meanwhile, according to Eurostat, the Eurozone’s economy declined by 4.9% in the fourth quarter.

EUR/USD technical outlook

The daily chart below shows that the EUR/USD price has been in a strong uptrend recently. This has seen it rise to the highest level since April 2018. The pair has also formed a head and shoulders pattern that is usually a bearish signal. It has also moved below the 25-day and 50-day weighted moving averages (WMA) while the Relative Strength Index (RSI) has formed a bearish divergence pattern. Therefore, the pair may continue to drop as bears target the next support at 1.1600.