By the end of the week, market volatility will increase amid the release of important economic statistics and a long holiday in the United States. Americans celebrate Memorial Day on May 31. On Thursday, GDP data for the first quarter will be released. On Friday investors are anticipating an inflation report, which is closely monitored by the Fed. It will have a strong impact on US Treasuries and the US dollar.
Yet, currently, traders are also awaiting inflation data with bated breath. Ahead of the release of statistics, investors are widely discussing the possibility of tightening the monetary policy. More and more market players wonder whether the Fed will follow in the footsteps of its colleagues from Canada and New Zealand. Many believe that Fed officials will start discussing the likelihood of reducing the bond-buying program. Besides, the speech of Randal Quarles on Wednesday also triggered such speculation.
"I don't want to overstate my concern. I do not expect a round of 1970s-style breakout inflation," Federal Reserve Vice Chair for Supervision Randal Quarles said. He added that he was "fully committed" to a new Fed strategy that aims to keep the monetary policy running full-throttle while jobs recover. He also commented on the case for why the "upside" risks of higher inflation may be mounting. The Fed may need to begin tightening monetary policy to restrain rising inflation.
"If my expectations about economic growth, employment, and inflation over the coming months are borne out ... and especially if they come in strong ... it will become important for the (Federal Open Market Committee) to begin discussing our plans to adjust the pace of asset purchases at upcoming meetings," Quarles said,
An actual interest rate increase, Quarles pointed out "remains far in the future."
Quarles agrees that inflationary pressures will ease over time. Still, there is reason to believe that inflation may be more persistent. Rapid wage growth will create a domino effect - prices will rise. Federal spending could fuel stronger demand from households as people return to work. At the same time, some have large savings.
Fed officials hope that in the near future inflation will weaken and the labor market will recover as well. In this case, it will be possible to ensure a smooth and well-planned transition to post-crisis monetary policy.
The US dollar is gaining momentum amid such market uncertainty. It held its decline near annual lows. Moreover, the US currency index managed to rebound above the important level of 90, although not for long. The current movement may lead to the formation of a double bottom and a subsequent rebound.
The recovery of the economy has slowed down and the US dollar took advantage of the situation. Yet, its rally is likely to be short-lived. The central bank of Canada reduced its QE program and the central bank of New Zealand signaled a rate hike.
The RBNZ's hawkish rhetoric pushed the NZD/USD pair to March highs. On Thursday, the quote continued its upward movement. The outlook for the US dollar remains bearish. So, the Kiwi may extend gains.
According to market expectations, US statistics are unlikely to be disappointing. This could trigger another wave of greenback sell-offs amid rising demand for riskier assets. Thus, NZD/USD may hit the level of 0.74 in the medium term.
ECB and Bank of England
The ECB, the Bank of England, however, as well as the Fed, stick to the soft approach to monetary policy unlike the RBNZ and the Bank of Canada. Canada and New Zealand have recently experienced a boom in the commodity market. In addition, manufacturing PMI reached multi-year highs. The UK, US, or Europe cannot boast of such results.
The lion's share in the economy of developed countries accounts for the service sector, which incurred huge losses due to the pandemic. Unemployment in this sector is rather high. Apart from that, high prices slow the pace of recovery. In this case, a soft monetary policy is the only way to get the economy back on track.
This time, economic and monetary policy cycles in different countries vary considerably. The Fed constantly emphasizes the need to maintain the dovish monetary policy. Investors will have to accept this fact. However, they will not stop looking for hints of an earlier tightening of monetary policy in the United States. Inflation data will be published on Friday and the NFP report will be published next week.
Bears loosened their grip on the US dollar a little. Yet, they are unlikely to lose control.
EUR/USD dropped to the 1.2200 level amid renewed talks about the reduction of the quantitative easing program at the end of the month. In the coming days, the weakness of euro bulls may continue, as the greenback will advance in the short term. If US GDP data is in line with forecasts, traders will focus on the report on durable goods orders for April. There may be a slowdown in investment growth.
US trading floors will be closed on Monday, May 31 as Americans celebrate Memorial Day. The US dollar is sure to benefit from it.
Despite the downward movement at the end of May, the forecast for the EUR/USD pair remains positive. Support levels are located at 1.2175, 1.2155, and 1.2105. Resistance levels are located at 1.2200, 1.2245, and 1.2266.
The pound sterling is likely to decrease. The GBP/USD pair fell to the two-week lows. A consolidation below 1.4100 will trigger a further decline to target level of 1.3990.
At the same time, consolidation above the level of 1.4135 send the pair to new highs.
