Ugly Reversal In EUR/USD

The Federal Reserve raised interest rates by 25bp today and Fed Chair Janet Yellen’s optimism plus hawkishness caught the market by complete surprise. Traders leaned heavily into short dollar positions after this morning’s weak consumer spending and inflation reports. Economists had been looking for retail sales growth to stagnate but instead they contracted by -0.3%, the largest decline since January 2016. Demand for products outside of auto and gas also fell short of expectations last month. Consumer prices turned negative, driving the year over year inflation rate down to 1.9% from 2.2%. After these reports, investors were sure that the Fed would drop its plans to raise interest rates again this year and we would hear mostly dovish comments from Janet Yellen. Instead the complete opposite happened. The Fed maintained its view for a third hike in 2017 and aside from acknowledging the drop in inflation, which she downplayed by attributing to one off factors, everything Yellen said was hawkish. She put on a brave face, talked up the improvements in the labor market and economy and shared the central bank’s plans to reduce its balance sheet by unwinding asset purchases. The dollar traded sharply higher in response. The Fed also raised its GDP forecasts, lowered its unemployment rate forecast and cut its projection for inflation. We have chosen to sell dollars versus the euro because there’s we believe tomorrow’s Eurozone trade balance report will be weak. Furthermore, GBP, AUD, NZD and CHF are not good options because of the upcoming Australian employment, New Zealand GDP, Bank of England and Swiss National Bank rate decisions.

Technically, today’s price action formed a very ugly reversal candle in EUR/USD that typically results in continuation. The currency pair has also broken below the 23.6% Fib retracement of the 2014 to 2016 sell-off near 1.1230 and is finding itself at the cusp of breaking below the 20-period SMA. We could easily see 1.1167, the June low and possibly 1.1110.