Will the EURUSD rise indefinitely only because of exiting dollar longs amid the spread of the omicron? Will the divergence in monetary policies of the Fed and the ECB restore the downtrend? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
This should have happened sooner or later. The Fed is getting more hawkish, suggests forgetting about the word “transitory” in relation to high inflation and insists on a faster QE tapering than is currently planned. The central bank is changing its priorities. Now, the Fed intends to curb inflation, although it was previously focused on bringing the US economy to full employment. Investors worry that the Fed will raise interest rates even before the labour market fully recovers and sell securities.
As a result of Jerome Powell’s speech before the Congress, the US stock indexes have been down, while Treasury yields have grown as well as the chances for the Fed’s monetary tightening. Federal Reserve Chair pointed to a strong economy and high inflation, suggesting they should accelerate the QE taper by a few months. Amid Powell’s hawkish comments, the likelihood of a rate hike in May rose to 50%, and traders bet on raising the rate by 60 basis points by the end of 2022. This is higher than before Powell’s speech but slightly lower than before the emerging of the omicron.
Reaction of US stock market to Powell’s speech
Source: Financial Times
When the S&P 500 is falling, and the Treasury yield is rising, the US dollar is strengthening. According to JP Morgan, only a significant deterioration of the epidemiological situation in the United States over the next two weeks will force the Fed to abandon the idea to accelerate the QE tapering.
The Fed targets inflation. This is evidenced by the statement of Fed Vice Chairman Richard Clarida that the price growth rate at 4%-5% is not a success. The question is when the European Central Bank will follow the Fed. The euro-area CPI has been up to 4.9% and the core inflation – 2.6%, which increases the pressure on the ECB. Analysts suggest Christine Lagarde and her colleagues too relaxed about rising inflation. They can continue with wishful thinking, but what if reality turns out to be different?
Dynamics of euro-area inflation
Thus, the divergence in monetary policies is playing on the side of the US dollar, and the omicron is on the side of the euro. The latter looks strange in itself. The new strain, exacerbating supply chain problems, is likely to be a bigger disaster for the export-led euro-area economy than for the US. Furthermore, the deterioration of the epidemiological situation and the associated risk aversion are reasons to buy safe-haven assets. Therefore, the greenback should have strengthened.
Weekly EURUSD trading plan
The euro is being supported by exiting speculative positions, both the EURUSD shorts and carry trades. The willingness of carry traders to buy funding currencies is a reason to buy the major currency pair, but it can’t continue indefinitely. If the price breaks out the resistance at 1.1365, it could be further corrected up to 1.1425 and 1.1455, but one should sell the pair there on the rebound. It will also be relevant to sell if the pair goes down below 1.129 and 1.127.
Price chart of EURUSD in real time mode
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