Euro on brink of breakout

The euro has had a tough time on the currency markets since the global financial crisis, falling from an index record high of 159 against a basket of currencies in April 2008 to lows of about 123 in 2010 and 2012. The currency has gained some strength following European Central Bank (ECB) chief Mario Draghi's July 2012 pledge to support the euro come what may, and, from a chartist's perspective, is now moving into interesting territory.

This week's chart, produced by Australian Technical Analysts Association member Alan Clement, shows the euro has been consolidating in a "falling wedge pattern" indicated by the red lines. The pattern is about eight years old and, the euro's weakness over that time notwithstanding, it is a long-term bullish signal.

That is because the price narrows between the trend lines as the pattern progresses, meaning buyers are taking increasingly aggressive stances against sellers narrowing the trading range. Congestion builds in the narrowing range, and when there is a breakout on the upside the market usually returns to a previous uptrend. In this case that would be the currency's run-up before 2008.

In mid-2011, the Euro Index spiked through the upper trend line but was unable to maintain its gains and reversed leading to further consolidation. We now categorise that as a false breakout.

Recent strength is pushing the euro to test the upper boundary of the wedge pattern. Should it break through and spend more than a month above the trend line, that would confirm a breakout and should be followed by a relatively quick move towards the resistance line at 139. There is another factor indicating that a breakout could be imminent. Such breakouts usually occur at a point two-thirds of the length between the base of the wedge, in this case the 2008 high, and the apex where the red lines would converge. That's the territory we are in now.

If the euro fails to break out now it should find support at the 123-127 zone. For the falling wedge to remain a sign of strength, the currency will need to remain above the 123 level for the longer term. A significant breach of the 123 support level would mean the likelihood of further weakness in the medium term. Alternatively, if the euro breaks on the upside and remains there, then the long-term falling wedge pattern will be said to be completed.

On the fundamental side, supply of the euro is shrinking as Europe's banks repay loans made by the ECB during the GFC, putting upward pressure on the currency price. That is exacerbated by a relative weakness in the US dollar against the euro as the Federal Reserve is printing more money that the ECB investors can gain exposure to through contracts for difference (CFDs), exchange-traded funds (ETFs), futures and options.

This column is not investment advice. rodmyr@gmail.com

Building momentum