EUR/USD rally hits a roadblock ahead of ECB

Next week, the Bank of Japan and the European Central Bank will announce their respective interest rate decisions, while there will be some key macro data to look forward to as well. Both the BoJ (Tuesday) and ECB (Thursday) are likely to hold their monetary policies unchanged, but the yen and the euro could move sharply nonetheless in the event of verbal intervention from either central bank.

The euro, in particular, has been very strong over the past several months amid speculation that the ECB would end its QE purchases programme earlier than expected due to consistent improvement in Eurozone data and higher rates of inflation. However, the appreciating exchange rate means the central bank will be even less willing to tighten its belt early. So, don’t be surprised if Mr. Draghi and co come out with some dovish remarks on Thursday, which could weigh on the euro.

In terms of key macro data, the latest PMIs from the Eurozone manufacturing and services sectors will be released on Wednesday and U.S. Advance GDP will come out on Friday. These figures should help to provide further direction for the euro/U.S. dollar (EUR/USD) currency pair exchange rate. It is worth pointing out that the U.S. dollar is looking severally oversold as well, so we wouldn’t be surprised at all if the EUR/USD were to head lower for a while.

Ahead of the above fundamental events, the EUR/USD has hit a bit of resistance around the 1.23 handle, with price unable to close decisively north of 1.2260 for five consecutive days now. Clearly, speculators have been happy to take profit at these "overbought" levels, as indicated for example by the RSI hovering around 70, after the sizeable rally at the start of the year. Whether this is just a pause for breath, a pullback or a trend reversal is not clear just yet.

If support at 1.2185-1.2200 area breaks down then expect the price to ease towards the next area of support between 1.2060 and 1.2090. The upper end of this range marks the high from last year, while the lower end was a significant low back in 2012, which has now been reclaimed. So, if the trend is still bullish, price shouldn’t go below this significant support area. However, if it does then one has to consider the alternative scenario: a reversal.

For us, a reversal would be confirmed if and when price takes out the low prior to the latest rally, in this case at 1.1930. Should this level break down then we could see the start of a significant correction. But for now, the trend is still bullish and in the event price takes out the aforementioned resistance range between 1.2260 and 1.2300 then we could be talking about the 1.25 handle next, with short-term term bullish objectives coming in around 1.2350 and 1.2425 – this being the 161.8% Fibonacci extension level of the last significant drop.