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EUR/USD: dollar is in play as earlier QE rollback by Fed is still on counter

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The U.S. inflation data released the day before caused a strong reaction in the markets.

Key US stock indexes hit new record highs, the 10 year Treasuries yield fell by about 1.5%, and the greenback dropped to nearly 0.2%.

According to the US Department of Labor, the nation's consumer price index rose only by 0.5% in July, compared to an increase of 0.9% a month earlier. At the same time, the core index expanded by 0.3%, falling short of the projected 0.4% increase.

Perhaps, the markets expected to see more aggressive inflation numbers, or they simply decided to "sell the fact."

Either way, the slowing inflation in the United States led to a sell-off of the dollar against almost all of its major rivals. As a result, the USD index moved into the red zone and dropped to 93.00, while EUR/USD jumped about 30 pips to 1.1750.

What makes the market's reaction to the July report particularly interesting is the fact that inflation is not really low. The annual CPI remained unchanged at 5.4%, contrary to the expected decline to 5.3%.

Thus, on the one hand, Fed officials may breathe a sigh of relief because price pressure has not increased, but on the other hand, continued growth in CPI may allow the central bank to announce the winding down of QE in the next six weeks.

With the US stock market trading at record highs, the regulator may begin to prepare investors in advance for the coming changes in monetary policy.

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At the moment there is no consensus on the timing of asset purchases reduction among Fed officials.

In particular, Kansas City Fed President Esther George believes it's time for it .

She thinks monetary support, combined with strong bailouts, has helped pull the US economy out of the crisis and put it on the road to recovery, signaling that it's time for the Fed to start withdrawing some of that support.

She said the standard for reducing the bond-buying program may have already been met by the current spike in inflation, recent labor market and expectations of continued strong consumer demand. "I support bringing asset purchases to an end under these conditions", she added.

The head of the FRB of Dallas Robert Kaplan believes the US Central Bank should begin to taper its monthly purchases of Treasury bonds in October.

For his part, Chicago Fed President Charles Evans said that the Fed should not announce these plans as early as the September meeting.

He said that they were approaching a point where it really would be appropriate to begin reducing asset purchases. However, he noted that he wanted to see a little more of the labor market reports before making his decision.

Thomas Barkin, the head of the Federal Reserve Bank of Richmond, put it along similar lines, pointing out that the US labor market may take a few more months to recover enough for the Fed to begin cutting back on its support for the national economy.

Strategists at Commonwealth Bank of Australia said that the general view coming from FOMC members at the moment is that the regulator is gradually approaching a reduction in asset purchases.

They announced that growing expectations of an imminent teeter-tottering in the US could provide support for the dollar.

After touching levels not seen since April 1 around 93.19 points, the USD index was down 0.19% on Wednesday.

On Thursday, the greenback changed little against its major rivals, trading near 92.90 points.

Westpac believes a further downward slide in the dollar is likely in the coming days, but it is unlikely to escalate into anything meaningful.

Westpac experts added that the U.S. currency is likely to continue to find support around 91.50-92.00 and could hit new highs beyond 93.50 when talk of taper starts to gain momentum later this quarter.

In addition, investors still worry that the spread of the delta variant of the coronavirus may undermine the global economic recovery.analytics61150ee6e08e5.jpg

Rabobank experts said that players should take into account the possibility of news about the reduction of QE from the Fed at a time when COVID-19 was still very visible in various parts of the world. They added that the consequence was likely to be a strengthening of the dollar, especially if the euro broke the 2021 low.

With the greenback weakening on a broad front triggered by July's US inflation data, the EUR/USD pair managed to recover from its lowest level since late March around 1.1710.

On Thursday it failed to develop a rebound from 4.5-month lows and went into consolidation mode.

The Eurozone statistics released today failed to impress the market participants.

According to the Eurostat information, the industrial production in the currency bloc expanded by 9.7% on the annualized basis in June, while on the contrary, it decreased by 0.3% on the monthly basis.

Analysts had expected the figure to have grown by 10.4% year-on-year and to have decreased by 0.2% month-on-month.

The nearest resistance for EUR/USD is at 1.1750 and further at 1.1770. From here, the bulls may target 1.1805 (21-day moving average).

In case the bearish pressure intensifies, the pair might test the multi-month lows around 1.1704. Further support is at 1.1650 and 1.1600.

Westpac noted that the pair EUR/USD has attracted buyers near 1.1700, but increased divergence in economic growth and monetary policy in the U.S. and the euro area may determine a breakdown of this level.

The bank's strategists said that in the next few months the theme of QE rollback by the Fed would be in the focus. They noted that the ECB might announce an extension of its anti-crisis asset purchase program without completing it in September, which would correspond to the current "dovish" strategy of the regulator.

They experts added that EUR/USD has the potential to strengthen toward 1.1800-1.1850 in the coming week, but the pair could eventually test new lows in the coming weeks as the Fed's monetary stimulus cut theme comes into play.

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