An excellent post by the McClellan Market Report on the euro (EUR/USD) prompted me to think about the bigger picture for EUR/USD and what might transpire over the coming weeks. As it stands now the euro is virtually in free-fall against the US dollar with two big eurozone events coming up towards the end of the month: the ECB announcement and press conference on January 22nd and snap Greek elections on January 25th.
On Friday we saw the first signs of panic since the most recent leg lower began in mid-December, however, the 1.2000 level proved to show stout support:
The McClellan Report makes the astute point that commercial traders are net long to the largest degree since July 2012, which happened to be an excellent time to get long EUR/USD; price bottomed at 1.2042 in July 2012 and proceeded to rally 1100 pips within the span of two months.
Given that the 1.2000 level is of huge importance from both a technical (previous support from 2010 and 2012) and psychological standpoint we can expect that a breach of this level will send price at least another 200-300 pips lower as sell stops are triggered and the market moves into capitulation mode. Such a scenario would set up a perfect environment (depressed sentiment, long liquidations, and an overextended downside move) for a violent counter-trend upside rip that should measure 800+ pips (a 38.2% retracement of the entire decline since May 2014):
As pointed out by McClellan, the fact that EUR/USD typically experiences trend reversals during January adds weight to the possibility of a counter-trend rally beginning during the next couple of weeks. However, once the explosive counter-trend snap-back rally runs out of steam the prevailing trend should reassert itself with force. The topping process which has played out since the early 2008 peak above 1.60 is one of the most significant chart patterns (descending triangle) currently out there in any major market. Simply stated, a breach of the 1.20 level indicates that EUR/USD is headed back to parity over the next 12-18 months.
In summary, the world's largest currency cross (EUR/USD) is probably within 1-2 weeks of a powerful rally that should take price up to the 1.25-1.27 area before the rally runs out of gas. Once the snap-back rally fizzles we should see the downtrend resume in EUR/USD as it reaches 1.10 during 2015 on its way to eventually regaining parity.