This week is going to be difficult and, as a result, volatile. We are expecting meetings of the world's central banks, which, of course, will be led by America. We will find out how the Federal Reserve will play the card and what path inflation will take.
Traders still refrain from making big bets, which is, in principle, understandable. However, judging by the general mood, market players are counting on a further slowdown in inflation and a softer approach from the Fed.
Inflation is expected to slow further to 7.3% in November, while reinforcing the view that a policy reversal is imminent. It is now widely believed that the Fed will raise rates by 50 bps on Wednesday. The U.S. central bank will also release quarterly projections on inflation, the economy, and the future trajectory of interest rates, which will be the most important information for the markets and will determine their direction for the rest of the year.
The European Central Bank is also due to raise rates this week by 50 bps, as is the Fed. However the U.S. central bank's meeting might overshadow the monetary news from Europe, not giving the euro a chance to gain more ground.
For now EUR/USD is staying at 1.0500, which is the best result in five months.
The euro has held up most of November's gains, but technical obstacles continue to prevent it from moving above 1.0600. Perhaps Tuesday's inflation data will be decisive in this case and will show whether the euro can overcome these obstacles in the early week.
In November, the euro was bought while the dollar was aggressively sold, the markets were betting on a slowdown in inflation in the U.S. Tuesday's data will either confirm or deny this view, which will have implications for EUR/USD.
If things go against investors' current plans, the euro could potentially fall quite low and make the 1.0600 level unattainable even in the event of an unexpected hawkish statement from the ECB on Thursday.
An ECB rate hike of 75 bps instead of 50 bps is possible, but unlikely, ING believes. In any case, U.S. inflation will be key.
In the opinion of economists at ING, "given the 10% EUR/USD correction off the late September lows, our preference would be that EUR/USD struggles to hold any gains over 1.06 this week and could end the week lower should US events oblige."
The Fed's decision on Wednesday is expected to raise the overall rate to 4.5%. More important, however, will be policymakers' opinions on whether to raise it above the 4.75% peak suggested back in September forecasts.
This information should have a significant impact on U.S. bond yields and the dollar less than 24 hours after the ECB verdict, for which there is still uncertainty in the financial markets.
Analysts believe the euro could rise if the dollar falls and if the ECB is more hawkish.
Investors tend to think the ECB will raise rates by 50 bps. An increase of 75 bps is supported in rare cases partly due to a decrease in overall inflation in November. However, European policymakers do not believe that the inflation situation will improve dramatically or right now.
As part of the December meeting, European policymakers are also expected to announce details of the central bank's plan to begin reducing the balance sheet, which has been greatly expanded by the various quantitative easing programs announced since January 2015. There is further uncertainty about how markets will react.
"In the euro area, sovereign purchases primarily act to ease credit conditions. As a result, ECB QE supports the euro, and unwinding the balance sheet should weigh on the currency at the margin," says Michael Cahill, a G10 FX strategist at Goldman Sachs.
The ECB is set to signal more rate hikes and yet there are limited opportunities for the euro to rise until the end of the year, confident in MUFG Bank. It's all about a big policy update on the balance sheet.
A EUR/USD decline below the support at 1.0515 would cancel the bullish scenario and send the quote lower.
Support is located at 1.0495, 1.0455 and 1.0410. Resistance is at 1.0580, 1.0625 and 1.0665.
