EUR USD s post Italian referendum rally could be a bull trap

Well, no one can say that they didn’t see that coming. After Brexit and US elections, stocks rallied hard after an initial wobble. The same, albeit to a lesser degree, has now happened in stocks with the case of the Italian referendum. In FX markets, the EUR/USD dropped to near the 1.05 handle overnight before bouncing back to climb above 1.07. It is just the way the markets function. But it is also worth pointing out the fact that the outcome of the Italian referendum was expected and was thus less of a shock than say Brexit or Donald Trump’s victory. What’s more, the markets have welcomed news out of Austria, where the Far Right anti-establishment and anti-EU candidate lost the election. Supporting sentiment further has been this morning’s mostly stronger-than-expected economic data from Europe with the UK’s services sector PMI suggesting growth continued to strengthen at its fastest pace since January and retail sales in the Eurozone increased by a cool 1.1% month-over-month in October.

Fundamentally, our long term bearish outlook on the EUR/USD has not changed. But in the near term, there is an increased risk for a larger counter-trend move before the bearish trend probably resumes. The EUR/USD will probably make its next big move on Thursday in reaction to the ECB’s policy meeting and press conference and then next Wednesday when the US Federal Reserve will mostly likely hike interest rates. Investors will want to know whether the ECB will extend its QE programme beyond the intended end date of March 2017, and how aggressive or otherwise the Fed will be in tightening US monetary policy. If these fundamental events still point to widening disparity between policy stances in the Eurozone and the US then the EUR/USD will most likely start its descend towards parity, after all.

Technical outlook: expect more chop in EUR/USD

In reaction to the outcome of the Italian referendum, the EUR/USD dropped overnight to test liquidity (sell stop orders) below the recent range around 1.0520. Here, it once again found support from the long-term between 1.0460 and 1.0525. After a gap and a sharp move lower, it was always likely to bounce back, in part due to profit-taking. But the size of the rally from the day’s low suggests that bullish speculators also stepped in to defend their ground here. As result, the EUR/USD has now climbed above the recent range high to test liquidity there (buy stop orders). The bulls will now want to see the EUR/USD hold above the 1.0660/85 area in order to see a potential rally towards the next key resistance area of 1.0850/80, which was formerly support. Ahead of this key area is another short-term resistance around 1.0725, which also needs to be watched very closely.

If the EUR/USD falls back below the broken 1.0660/85 resistance on a closing basis then this would be deemed a bearish outcome. It is also worth pointing out a couple of things here. First that the long-term charts still point lower. Second, the repeated bounces around the 1.05 handle (or more specifically 1.0460-1.0525) means lots of sell stops will be building up below here. In other words, this rally could be a trap for the bulls. Once/if the bearish trend resumes, the cluster of sell stop orders below the recent range will likely act like a magnet to pull price down before we see another large leg lower. For now though, the past of short-term path of least resistance appears to be to the upside. But traders will need to be wary of the long term picture, which is still bearish.