While the ECB is marking time with its ultra-easy monetary policy, the Fed may soon finish QE and raise rates. How will the divergence in monetary policies affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
Bank of Canada Governor Tiff Macklem says the economy is getting closer to meeting the conditions for raising interest rates. Central banks should be focused on outcomes rather than on timelines. When regulators started QE, they assumed the programs would end at the end of the pandemic. As the result is achieved, the regulators could end the asset purchase programme, as the BoC did. The problem is, the Fed is not the Bank of Canada. An early stimulus withdrawal by such a giant could result in a panic in financial markets, further strengthening the US dollar.
Everybody says that the Fed acts too slowly. According to Jefferies, the US has entered the toughest job market since the 1950s. Even if the temporary factors that contribute to the increase in inflation by 1.5% disappear in 2022, the wages, the contribution of which is estimated at 1%, will continue to fuel the rise in consumer prices. This is unlikely to change in the next year, forcing the Fed to act aggressively eventually. The former president of the Federal Reserve Bank of New York, William Dudley, believes that the central bank will start raising the federal funds rate and quickly bring it to 3%, which is significantly higher than the 1.75% expected by the regulator by the end of 2024.
Now, investors’ expectations are ahead of the Fed’s forecasts for the federal funds rate, but what if they swap places? The derivatives market estimates the chance of two rate hikes in 2022 at 83%. After the FOMC September meeting, it was 22%. CME derivatives signal that the central bank will raise rates three times with a probability of 54%. The increase in forecasts encourages the EURUSD bears to break through 16-month lows.
The euro bulls are too weak to fight back. According to Bloomberg experts’ forecasts, the euro-area inflation will reach 4.2% at the end of 2021, but in a year, it will slow down to 1.6%, which is below the ECB’s 2% target.
Forecasts for euro-area inflation
Christine Lagarde says they see wage growth next year potentially rising somewhat more than this year, but the risk of second-round effects, including supply-chain disruptions, remains limited. The European labour market is much less flexible than the American one, and there are fewer supply problems in the euro area than in the US, which limits the likelihood of excessive wage increases and inflation. In such an environment, the ECB can well extend the QE through 2023. And even though Deutsche Bank urges the ECB to reduce monetary stimulus citing their excessive side effects, Germany is not the only country in the euro area. The European Central Bank should take into account the interests of all euro-area member states, which also limits the prospects of monetary normalization.
Weekly EURUSD trading plan
The divergence in the monetary policies of the Fed and the ECB is the primary bearish driver for the EURUSD. It is not clear where the price will stop falling. It could stabilize at the levels of 1.133 and 1.122 indicated in November or continue falling lower. Nordea Markets expects to see it at 1.085 at the finish in 2022, and this forecast, which seemed fantastic just recently, is getting more real. It is relevant to hold down sell trades entered at 1.157 and 1.1435 and add up to the positions on corrections.
Price chart of EURUSD in real time mode
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