Markets do not know if the Fed will become worried about the Delta, but risk appetite is growing. The S&P 500 is rallying up, and investors are selling off Treasuries betting on the economic growth. Where will the EURUSD go amid uncertainty? Let us discuss the Forex outlook and make up a trading plan.
Weekly euro fundamental forecast
Until mid-August, investors wondered if the Fed was right talking about the temporary nature of highs inflation. The FOMC doves argued that soon the rate of price growth would slow down, the hawks insisted on the long-term nature of the increased PCE values. The rapid spread of the Delta across the United States created another puzzle. Will the Fed pay attention to the pandemic?
Which way will Jerome Powell and his colleagues go? The way of the Reserve Bank of New Zealand, which cancelled the rate hike due to nationwide isolation? Or will they follow the example of the Bank of South Korea, which has tightened monetary policy, despite the raging pandemic in Asia? The Fed will hardly abandon its plan to normalize the monetary policy. Still, on the eve of the Jackson Hole summit, the market has downgraded the likelihood of a hawkish surprise from the Fed chairman so much that if it happens, the EURUSD will sharply drop.
Considering the next wave of the pandemic in the United States, large banks are beginning to talk about a late start in the process of tapering the QE. Sachs gives a 45% chance that the Fed will announce monetary tightening in November. Barclays is talking about the same month, predicting that the actual reduction in monetary stimulus will begin in January.
The problem is that no one, including the Fed, knows exactly what the US economy will look like in a year. Will it be sustainable, which, in addition to high inflation, will require an aggressive tightening of monetary policy? Or is it a partial, incomplete, and slow recovery? In the medium term, following the acceleration of GDP in the second quarter, the leading indicator from the Federal Reserve Bank of Atlanta expects a slowdown to 5.7% in the third quarter.
Forecast for US GDP
Source: Atlanta Fed
And yet, the markets are rather positive despite the spread of the Delta. The S&P 500 hits its 51st record high in 2021, and the 10-year Treasury yield is rising on expectations that the Fed will not tighten monetary policy too aggressively. This will support economic growth. Investors are too optimistic, pressing down safe-havens. I would not be surprised if the revision of the US GDP for April-June upward from the current 6.5% will push the stock indices even higher, creating new difficulties for the greenback.
The euro was supported by the ECB officials. Vice President Luis de Guindos did not rule out that the central bank’s GDP forecast could be raised in September. Chief Economist Philip Lane noted that the euro-area economy is not too far from the regulator’s estimate of 4.6% in 2021. Given that the pandemic in the US is spreading faster than in the EU, is the euro too low?
Dynamics of EURUSD and COVID-19 cases (USA-Europe)
Source: Nordea Markets
Weekly EURUSD trading plan
Furthermore, Lane noted that the ECB is willing to take action if the Fed’s monetary policy normalization affects the euro-area economy. It is a hint at boosting the euro-area QE if the bond yields increase. Therefore, I maintain the bearish outlook for the EURUSD and recommend selling the pair on the price growth to 1.18-1.1815 or on the drop below the support 1.1725.
Price chart of EURUSD in real time mode
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