Investors curious about further actions of Fed amid robust economic recovery

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There have been a lot of talks recently that the Fed may start reducing QE programs earlier than planned.

Investors fear that the regulator will have to take such a step amid a rapid economic recovery, as well as rising inflation in the country.

Traders are also concerned about the renewed growth of the US dollar. So, in the first half of the week, the yield on 10-year US Treasury again broke the 1.6% level. An increase in the bond market may lead to a decline in the stock market. So, traders will again shift attention from the stock market to the bond one.

On Tuesday, key US indexes had been falling for the second day in a row. The Dow sank by 1.4%, the NASDAQ Composite declined by 0.1%, and the S&P 500 index dropped by 0.9%.

The sell-off in the stock market helped the greenback as a safe-haven asset to recoup some of its losses. However, the US dollar index still holds slightly above the key support in the area of 89.20-89.60.

The main downside risks for US stock indexes remain tax increases proposed by the Joe Biden administration and the potential curtailment of stimulus measures from the Federal Reserve.

If the negative effect of the first event is likely to be eased over time, then more and more concerns have recently been voiced about the possibility of the second event.

The topic of rising inflation expectations in the United States continues to be one of the hottest ones.

Some investors are betting that inflation is likely to increase significantly in the coming months due to deferred spending, supply chain bottlenecks, and a jump in commodity prices.

As the US economic recovery gathers momentum, inflation expectations and real interest rates continue to rise, market participants are beginning to discuss when the Fed starts reducing its quantitative easing program, Danske Bank experts said.

"We would not be surprised if, by June, a majority of the FOMC Committee, namely its 19 members, will discuss a spike in interest rates in 2023. Seven FOMC members are currently talking about raising rates in 2023 and three in 2022. We expect the Fed to formally start the discussion on reducing QE in September," they added.

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Meanwhile, Fed officials have repeatedly stated that they assess the inflation risks as temporary, pointing to the possibility of a short-term rise in inflation above the regulator's target of 2%.

According to some estimates, in the second quarter, the US GDP growth will be about 10%. However, in this case, the Fed is likely to say that this is a temporary factor, stating that such growth rates are the highs of the current cycle, primarily thanks to fiscal stimulus measures. After reaching highs, GDP growth will return to its long-term trend of just below 2%.

It is obvious that the US Central Bank remains committed to a super-soft policy. This view is supported by recent comments from Federal Reserve officials. Only the statement of the President of the Federal Reserve Bank of Dallas, Robert Kaplan, about reducing QE differ. Everyone else is sure that now is not the time. And this is bearish for the US dollar, " strategists at National Australia Bank said.

Although the greenback has gained ground amid risk aversion and just risen above 90, it lacks upside potential, analysts at Westpac stressed.

Fed officials advise remaining patient, while the eurozone recovery indicators continue to narrow the gap with the US. So, the US dollar index will decline over the next few months, they said.

According to UniCredit economists, investors can quickly open short positions on the US currency if the Federal Reserve maintains a soft monetary policy despite higher inflation.

Any strengthening of the US dollar will ultimately remain limited, which may enable the bears to take the upper hand.

Analysts at Goldman Sachs believe that the resumption of economic growth in Europe and a possible slowdown in the US economy may lead to a further strengthening of the euro against the greenback.

They predict that the EUR/USD pair will reach 1.2500 in the next three months.

In addition, the bank noted that the tightening of the monetary policy by the Federal Reserve at this stage is unlikely, which is also negative for the US currency.

Nevertheless, the situation may change at any moment.

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The ECB has promised to accelerate the pace of bond purchases in the second quarter. However, in June, the regulator may announce the beginning of the curtailment of QE. At least, that is what Martins Kazaks, a member of the ECB's Governing Council, thinks.

"If financial conditions remain favorable, in June we can decide to buy less," Kazaks said

Market participants are likely to think that this is the beginning of a tightening of the ECB's monetary rate, which may support the euro.

Meanwhile, another ECB official, Olli Rehn, said that the ECB could adopt the Fed's approach of allowing inflation to exceed the 2% target. This may lead to a continuation of ultra-loose monetary policy, which is bearish for the euro.

Thus, along with the improvement of the epidemiological situation in the UE and the US, the main driver for the EUR/USD pair may be speculation on the further steps of the US and European central banks.

On Tuesday, the euro/dollar pair reached 1.2180, the highest levels since the end of February 1.2180, but then slightly corrected due to increased demand for the US dollar.

Last week, the EUR/USD pair recovered from the area of 1.1994–1.1989. We still expect a retest of the 1.2210–1.2243 area (78.6% correction for the Fibonacci movement observed this year and the February high), and then a rise to 1.2349 (2021 high), the strategists of Commerzbank noted.

The decline is likely to be limited by the 55-day Moving Average at 1.1965 and the 200-day Moving Average at 1.1950. The resistance level is 1.1943, which is the low of April 19. If the pair breaks this level, it may extend losses, they added.

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

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