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EUR/USD: dollar says goodbye to hot August and hints to the euro that it is too early to relax, because there is no less


August turned out to be rather "hot" for the dollar. Expectations of an early tightening of monetary policy by the Federal Reserve pushed the greenback to the highest levels since November 2020. However, these expectations weakened somewhat, which served as a reason for the USD to pull back from multi-month peaks.

A month ago, investors believed that the Fed would announce the details of reducing the asset repurchase program at the annual symposium in Jackson Hole, but the rapid spread of the COVID-19 delta variant in the United States, apparently, forced the central bank to adjust its plans.

Speaking at the end of last week at a symposium, Fed Chairman Jerome Powell dispelled market fears about a rapid reduction in incentives and an increase in interest rates.

These statements supported purchases of risky assets and put pressure on the dollar.

As a result, key US stock indexes updated record highs, the greenback fell by about 0.4%, and the EUR/USD pair reached its highest level since the beginning of August.

After more "tough" than expected statements by a number of Fed representatives, dollar bulls hoped to hear such comments from Powell.

Known for his ability to smooth out the positions of fellow hawks, Powell chose a neutral position.

However, the modest reaction of the USD exchange rate indicates that the dollar bears also did not hear anything new for themselves that could encourage them to be more active.

In fact, Powell only repeated the conclusion of the Fed's July minutes published earlier – the majority of the leadership of the US central bank believed then that it was possible to start reducing the volume of asset repurchases by the end of the year.


Assessing the changes since the last FOMC meeting, Powell noted both a positive shift – a strong report on the US labor market for July, and the acceleration of the spread of the delta strain of coronavirus in the country, promising to assess incoming data and emerging risks.

At the same time, Powell stressed that the reduction of QE, which may begin this year, will not directly signal an increase in interest rates, since the American economy must pass more stringent tests for this.

"Powell did not say anything about the timing of the curtailment of monetary stimulus, and his repetition that the Fed's decision to reduce QE would not be related to the decision to raise rates was interpreted as an implication that there would be a time gap. This, in turn, led to the fact that the market took a position with respect to the regulator – incentives will be reduced, but not so quickly as to stop the recovery," ANZ experts said.

According to analysts, Powell seems to have managed to walk a fine line, pleasing both those who demand that the central bank begin to curtail the asset repurchase program, and opponents of raising interest rates in the foreseeable future.

It is obvious that Powell is taking a very cautious position, thereby trying to prevent a repeat of the panic in the financial markets, similar to 2013, and trying to prepare them for a reduction in monetary support as the US economic prospects improve.

The main conclusion from Powell's recent speech can be made as follows. So far, everything is in place for the beginning of a gradual curtailment of stimulus measures by the central bank, and then everything will depend on how long inflation in the United States will last above the central bank's target level of 2% and whether the national labor market will continue to recover at the same pace.

With his comments, Powell caused the dollar to weaken across the entire spectrum of the market, returning it to an important level of support in the face of the 50-day moving average. However, it should be recognized that this movement was not particularly strong, and at the beginning of this week it did not receive serious development.

On Monday, the USD index is trading just above the two-week lows recorded earlier in the area of 92.60 points. Further down, there are 92.45 (mid-August low) and 91.80 (late July low).

Capital Economics experts believe that the dollar's weakness will not last long.

"We think that the expectation of a tightening of the Fed's monetary policy in response to persistently high inflation will lead to an increase in the yield of treasuries and a strengthening of the greenback in the coming months," they noted.


Danske Bank believes that a further improvement in the situation on the US labor market and a reassessment of the current very low real rates will add the potential for an increase in the yield of 10-year US government bonds.

"Although the US central bank's announcement of a reduction in QE this fall should not be a big surprise for the market, we believe that the recent smoothing of the treasury yield curve is too early in the cycle. We still have a bond market that needs to adapt to significantly lower asset purchases from the Federal Reserve. In addition, the first rate increase by the regulator is also approaching in time," the bank's strategists said.

They expect that the Fed will announce a reduction in QE at the September meeting, and that the reduction will actually begin in the fourth quarter and will be completed next summer, and there will be a rate hike at the end of 2022.

Soon there will be new data on the economic consequences of the "Delta" variant and recent changes in the dynamics of consumer prices, when the next release on US inflation will be released (September 14). In addition, before the next FOMC meeting, another report on employment in the United States will be published on September 3.

According to the consensus forecast of analysts polled recently by Reuters, this month the US economy will add another 725,000 jobs, in addition to the almost 1.9 million created in June and July.

If in December last year, unemployment in the United States was 6.7%, then in July it was 5.4%.

As the indicator decreases, the balance of power between the camps in the Fed will shift in favor of the hawks, whose voices are heard louder and louder.

"We expect the dollar to regain some lost ground this week, as investors remain concerned that COVID-19 will slow down the global economy," analysts at Commonwealth Bank of Australia said.

"Friday's employment figures in the US non-agricultural sector will lead or refute the arguments in favor of the announcement of a reduction in QE at the September FOMC meeting," they added.

So far, traders continue to evaluate Powell's comments, and the prospect of the central bank curtailing monetary support without seeking to raise interest rates does not help the dollar much, but the markets are probably already looking at the European Central Bank meeting and the press conference of its president Christine Lagarde next week, September 9, UniCredit says.

Last Wednesday, the ECB's chief economist Philip Lane said that at this meeting it would be too early to talk about curtailing asset purchases under the PEPP program and that they will continue at least until the end of March.

On Monday, another ECB representative, Francois Villeroy de Galo, spoke in a similar vein, saying that there is no rush to make a decision on PEPP at the ECB's September meeting.

According to him, interest rates in the euro area will remain favorable, and the PEPP program will be in effect at least until March 2022.

Francois Villeroy de Galo also noted that the ECB has more time to make a decision on reducing asset purchases than its American counterpart.


Apparently, the ECB is not very interested in strengthening the euro against the US dollar, and if the data on inflation and employment in the eurozone do not present negative surprises, the ECB will stick to the current policy for several more months.

In addition, there is already less than a month left before the general elections in Germany, scheduled for September 26.

"The data of public opinion polls fluctuate greatly: the SPD in the last couple of weeks has noticeably approached the CDU/CSU bloc, which now has almost the smallest support for the cycle. Will the center-left, led by the SPD, win the elections? This would be similar to the scenario of the victory of the "greens", which we considered earlier: strengthening European integration, strengthening fiscal stimulus. However, even together, the Social Democrats and the Greens, although they are inclined to partnership, will not be easy to form a majority, since their total support is below 40%. A minority government is possible in Germany, but it has not yet emerged in the entire post-war period. The liberal FDP is a dubious candidate for this coalition, and the radical "Left" might agree, but even with them there may not be enough seats for a majority. In general, follow the news," Saxo Bank said.

As a reaction to Powell's speech, the EUR/USD pair rose above 1.1800, but ended the last five days near 1.1795.

The pair again failed to grow above 1.1800 at the beginning of this week, switching to consolidation mode after updating three-week highs around 1.1810.

The main currency pair needs to stay above 1.1800 to attract more bulls and continue to grow to 1.1900 or 1.2000, according to UniCredit.

The initial resistance is at 1.1825 (the level near which the 55-day moving average passes) and then at 1.1860 and 1.1910.

On the other hand, support is located at 1.1780 (the mark that restrained growth last week), followed by 1.1740, 1.1725 and 1.1695.

It is assumed that the outlook for the pair remains negative as long as it is trading below the 200-day moving average at 1.2001.

The material has been provided by InstaForex Company -