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A delicate balance: EUR/USD continues to float as the dollar cannot yet determine where the Fed will move next

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The dollar is still at a crossroads, continuing to fight for the direction of movement.

On the one hand, the headwind in the form of real yields in the United States, testing record lows, undermines the dollar's strength, on the other hand, the demand for safe-haven assets limits the decline of the USD amid fears that the delta variant of the coronavirus may hinder the recovery of the global economy.

The main currency pair is also still unable to decide where to move next.

"The EUR/USD pair continues to change slightly, stuck in a narrow range, as both currencies are held back by various factors," UniCredit analysts said.

On Monday, the euro rose by more than 0.3% against the US dollar, despite the fact that the data for Germany turned out to be worse than forecasts.

The business climate index in the country unexpectedly fell to 100.8 points in July against the preliminary estimate of 102.1 points.

Since no important macroeconomic reports on the United States were published yesterday, a positive attitude to risk supported the euro.

The key US stock indexes extended a helping hand to the bulls in EUR/USD, which rose moderately following the results of Monday's trading, while reaching record closing levels for the second consecutive session.

The EUR/USD pair marked the high since Thursday at 1.1816 and ended yesterday near 1.1805, maintaining a positive attitude against the background of the weakening of the dollar with a wide front.

The decline in the US currency was also facilitated by the fall on Monday of the real yield of 10-year treasuries to a record low at -1.123%.

The EUR/USD pair was under pressure on Tuesday, as the risk sentiment weakened somewhat, but then it was able to recover quite quickly and rose above 1.1830.

Nevertheless, the demand for the dollar remains ahead of the two-day FOMC meeting.

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One hint from the Federal Reserve that a reduction in quantitative easing may begin in the near future will be enough to send the USD to new highs, according to strategists at Commonwealth Bank of Australia.

Bank of America analysts believe that at the July meeting, the Fed will lay the groundwork for the upcoming announcement of the curtailment of QE, which will serve as confirmation of the divergence of monetary policy in the United States and Europe.

In this case, the greenback may strengthen, and the bears on EUR/USD will have a chance to continue moving downwards.

Bank of America still expects to see the EUR/USD pair at the level of 1.1500 at the end of 2021.

Citigroup analysts believe that the tone of the Fed's statements is likely to remain generally neutral this week.

"The US central bank is likely to recognize the possibility of a new wave of COVID-19, will remain optimistic about the economic prospects and will closely monitor the risks of rising inflation. The central bank will also hold detailed discussions on the reduction of quantitative easing and will probably make some decisions on the nature of the QE reduction and the policy sequence, but without disclosing full information or timing," they predict.

In this scenario, you should not expect noticeable changes from the dollar to other major currencies before the end of the Fed meeting on Wednesday. In particular, the EUR/USD pair will continue to trade in recent ranges.

According to OCBC analysts, Fed Chairman Jerome Powell is unlikely to deviate from his dovish rhetoric amid an increase in cases of COVID-19 infection in the United States associated with the Delta strain. This may weaken market expectations for an increase in the federal funds rate and put pressure on the dollar, analysts say.

Standard Chartered shares a similar opinion.

"We expect that the head of the US central bank, Jerome Powell, will show more patience than a number of recent speakers from the Fed, with regard to reducing inflation, while domestic economic conditions still point to a weak labor market," the bank's strategists said.

"Powell's dovish bias is likely to lead to an increase in long-term interest rates due to the rally of instruments that contain an inflation indicator and a decrease in market fears about a slowdown in medium-term growth. Paradoxically, this is likely to be negative for the dollar, because global uncertainty about the policy response to higher inflation will be reduced," they added.

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Since the Fed met just six weeks ago, what appeared to be a cloudless backdrop for the debate on curtailing monetary stimulus has been overshadowed by a fourfold increase in the number of daily infections in the US caused by the more contagious delta variant, to levels seen during the outbreak of the virus last summer.

In addition, the recent slowdown in the rate of vaccination in the country may hinder the expected recovery of the national economy.

Goldman Sachs analysts point out that the growth of activity in the US service sector is weakening. They expect a significant slowdown in the economic recovery in America in 2022.

According to the bank's forecast, the US economy will return to trend growth rates (1.5-2%) in the second half of next year.

Also, Goldman Sachs lowered the estimates of the increase in US GDP for the third and fourth quarters of this year by 1% - to 8.5% and 5%, respectively.

On Thursday, the US will release the first estimate for economic growth in the second quarter, which is expected to be the peak of recovery after the pandemic.

On the other side of the Atlantic, on Friday, the eurozone will publish GDP data for the second quarter, which will give investors some idea of the strength of the region's economic recovery after a double recession.

On the same day, there will be releases on inflation and unemployment in the currency block.

If the statistics on the eurozone are positive, this, along with the dovish comments of the Fed leadership, will allow the EUR/USD pair to overcome the 1.1900 mark.

In addition to the Fed meeting, the quarterly reports of a number of large US companies are of interest to investors this week.

Further growth of the US stock market will put pressure on the dollar. If the quarterly reports of US tech giants disappoint, this will trigger a sell-off of shares and a decline in the main currency pair.

The initial support is expected for EUR/USD at the July low of 1.1750, followed by the levels of 1.1717 and 1.1700, near which the pair was last seen at the end of March.

Meanwhile, the bulls' chances will increase if the pair continues to rally above 1.1840. Next, it can target a strong resistance around 1.1920.

The material has been provided by InstaForex Company - www.instaforex.com