Euro / Dollar Week Ahead Forecast: Central Bank Combo Could Prompt Range Breakout

• EUR/USD could see choppier trade this week
• Range-bound consolidation could be resolved
• As Fed, ECB decisions land in quick succession
• Fed dots, ECB QE decision & CPI forecasts key

Image © European Central Bank.

The Euro to Dollar rate was little changed last week but may see choppier trade over the coming days with policy decisions of the Federal Reserve (Fed) and European Central Bank (ECB) possibly answering if the Euro can continue to hold onto a major support level just beneath 1.13.

Europe’s single currency has been consolidating within a narrow range against the Dollar ever since late November’s global market sell-off prompted what appeared to be a market wide abandonment of wagers against lower yielding currencies that had been borrowed and sold previously in order to fund bets on higher yielding assets elsewhere.

That consolidation kept the Euro-Dollar rate contained between 1.1227 and its high of 1.1354 last week but with key Fed and ECB monetary policy decisions landing on the wires in quick succession over the coming days there’s a chance that price action this week could yield a decisive break in one direction or another for the single currency.

“The EUR has held to a 1.1250-1.1350 range for the better part of the past two weeks as it consolidates its losses through November (that pulled it into oversold territory),” says Juan Manuel Herrera, a strategist at Scotiabank.

“EUR’s failure to make a material run at the 1.14 mark points to its downward trend resuming in the days ahead toward a re-test of 1.12 and the Nov 24 low of 1.1186. Intermediate support is 1.1228,” Herrera also said in a Friday research note.

Above: Euro-Dollar rate at weekly intervals with key moving-averages and Fibonacci retracements of 2020 recovery indicating likely areas of support.

• EUR/USD reference rates at publication:
  Spot: 1.1288
• High street bank rates (indicative band): 1.0893-1.0972
• Payment specialist rates (indicative band): 1.1186-1.1232
• Find out about specialist rates, here
• Set up an exchange rate alert, here
• Book your ideal rate, here

The Euro-Dollar rate has probed repeatedly below the support level offered by the 61.8% Fibonacci retracement of 2020’s recovery trend but has rarely been able to close beneath the threshold on a daily basis and is yet to sustain a weekly close beneath it.

However, there’s a risk that this Wednesday’s Fed decision would prompt a renewed foray to the downside if the latest economic forecasts from the bank suggest that it could begin lifting U.S. interest rates by the second quarter of next year and on three occasions or more.

“A recovery in risky assets and more stability in US front-end rates have allowed the Dollar to dribble lower from its late-November highs. The currency’s near-term direction will likely be determined by the Fed,” says Zach Pandl, co-head of global foreign exchange strategy at Goldman Sachs.

“If the “dot plot” at this week’s FOMC meeting shows a two-hike median for 2022 we may see the recent weakness extend, while a baseline of three or more hikes for 2022 would likely result in a return to USD appreciation (markets currently price 2.6 Fed rate hikes next year),” Pandl also said.

The Fed is widely expected to accelerate the tapering of its quantitative easing programme this week so that it ends sooner than the June 2022 date that was envisaged and announced back in November.

That would create room for its interest rate to be lifted sooner than previously thought likely by the market and its Wednesday’s updated dot-plot of policymakers’ own forecasts that will provide a loose guide to how much sooner this is likely to happen.

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This is the main point of interest for the market after 10 voting members of the Federal Open Market Committee - which is a decisive majority - indicated in recent weeks that they could support a decision to end the $120BN per month QE programme sooner at this week’s meeting.

Wednesday’s Fed decision is followed by December’s update from the European Central Bank, which will have the final say over whether the Euro-Dollar rate is condemned to break lower beneath the support line at 1.1292 or if it’s able to extend late November’s recovery from beneath 1.1200.he Euro would face multiple layers of technical resistance on the charts in the event of any rebound, and the catalyst for such an outcome would likely be found in the ECB’s new inflation forecasts and the anticipated decision - or lack thereof - about the future of its quantitative easing programmes.

“The ECB is likely to reassess its policy framework, winding down PEPP but topping up the APP. The risk is a delay in the status of the APP program, highlighting the emergence of the new variant,” says Mark McCormick, global head of FX strategy at TD Securities.

“For the first time in a while, the EUR offers a nice discount, trading around -1 standard deviation. Short positioning is a crucial driver, underscoring the prospects of a knee-jerk bounce next week, especially as hedge funds are a big driver of the short position. The rub for the EUR is that asset managers remain long, even though they have dialled back exposure over six months,” McCormick also warned last Friday. 

Above: Euro-Dollar rate at daily intervals with Fibonacci retracements of late September’s extension lower indicating likely areas of technical resistance to any further rebound.

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The ECB has already telegraphed to the market that its €1.85 trillion pandemic-inspired quantitative easing programme is set to end in March when the monetary allocation to it is likely to be all but exhausted, although many in the market have come to expect a compensatory top-up to the monthly bond purchases carried out under its original quantitative easing programme known as the Asset Purchase Facility, or APP, to be announced this week.

However, there’s now a danger that the ECB decides to eschew the latter decision in pursuit of greater clarity about the scale of the risks posed to the Eurozone economy by the latest strain of the coronavirus, and also potentially in order to observe developments around inflation.

This would be an upside risk to the Euro-Dollar rate to end the week, and one that would grow larger still if the ECB’s new inflation forecasts were to show the Eurozone’s inflation rates sitting at the symmetric 2% target in the middle of the forecast horizon.

The latter would be a sign that the bar or barriers to any eventual increase in the ECB’s interest rates are beginning to fall.