EUR/USD Weekly Forecast: Federal Reserve between a rock and a hard place

• Pandemic-related disruptions are likely to push inflation even higher around the world.
• The US Federal Reserve will announce its monetary policy decision on January 26.
• EUR/USD is poised to resume its decline in the long term and could pierce 2021 low.

The EUR/USD pair gave up its latest gains and returned to its comfort zone, just a handful of pips above the 1.1300 figure. The pair lost the most on Tuesday when US traders returned to their desks and pushed government bond yields to levels last seen in February 2020.

Covid, inflation and yields

The yield on the 10-year Treasury bond peaked at 1.903% on Wednesday, as speculative interest reflected its concern about skyrocketing inflation, anticipating the Federal Reserve would have to raise interest rates sooner than anticipated. The 2-year note yielded 1% for the first time in two years, on Tuesday.

But it is not just in the US. The 10-year German bund yield traded in positive territory for the first time in almost three years as well, as German inflation was confirmed at 5.3% YoY in December. For the EU, meanwhile, it hit 5% in the same period, both multi-decade highs.  In the same month, US inflation hit 7% YoY, a rate unseen since 1982.

The near term scenario does not look promising. The world paused back in March 2020 amid the appearance of the COVID-19 pandemic and spent most of 2021 struggling with supply shortages and bottleneck issues whilst on its way to economic recovery. At the end of November 2021, South Africa announced the discovery of a new coronavirus strain, Omicron. Little did we know three months ago that the new variant would spread like wildfire globally, and push the economic recovery two steps back amid record levels of contagion, globally.

In December, cases around the world stood at around 500K. In the last couple of weeks, the number of new cases detected globally stood above 3 million per day, with the US reporting 1.35 million in 24 hours. Governments are avoiding lockdowns, but the large number of workers unable to attend their jobs are affecting businesses and hence, economic progress.

This week, the US reported that Initial Jobless Claims for the week ended January 7 unexpectedly jumped to 286K, much worse than the 220K expected and the highest since October.

Employment could be a drag for policymakers

Central bank decisions usually rest on two legs: full employment and controlled price pressures. Until December, the US Federal Reserve relied on what it called “the jobs market at close to full employment” to accelerate an aggressive reduction of its financial support to tame inflation.  The big question these days is whether the Fed will actually be able to move as planned, as the job sector begins suffering from the latest wave of coronavirus.

The US central bank will have a monetary policy meeting next week and will announce the monetary policy decision on January 26. No action is expected at this time, although market participants are hoping for clearer hints about upcoming rate hikes. Investors are pricing in a first rate hike for March 2022 and at least three hikes through the year.

The European Central Bank, on the other hand, is on the other end of the spectrum. European policymakers keep acknowledging that persistently high inflation may last longer than anticipated and even move above their comfort zone, but up to today, they are not willing to retrieve financial support, maintaining a cautious stance.

US first-tier events coming up

Beyond employment and inflation data, the macroeconomic calendar included the January ZEW Survey, which showed that the Economic Sentiment improved in the country and the Union, although the assessment of the current situation contracted sharply. The preliminarily estimate of EU Consumer Confidence came in at -8.5, better than anticipated.

The upcoming week will start with Markit publishing the preliminary estimates of its January PMIs for the EU and the US. Later in the week, Germany will publish the January IFO survey on Business Climate and the February GFK Consumer Confidence Survey, while the EU will release the January Economic Sentiment Indicator.

The US will provide investors with several first-tier figures. Beyond the US Federal Reserve’s decision, the country’s calendar includes the first estimate of Q4 Gross Domestic Product,  foreseen at 5.8% QoQ, and December Durable Goods Orders. At the end of the week, the US will release the Core Personal Expenditures Price Index, the Fed’s favourite inflation measure.

EUR/USD technical outlook

From a technical point of view, the EUR/USD pair seems poised to resume its decline. It is finishing the week near the 23.6% retracement of its 1.1691/1.1185 decline at 1.1305, after nearing the 61.8% retracement of the same decline at 1.1495 in the previous week.

On the weekly chart, the 20 SMA has crossed below the longer ones and the aforementioned Fibonacci resistance level, somehow reflecting strong selling interest. Technical indicators, in the meantime, resumed their declines within negative levels after correcting oversold conditions reached back in December.

The pair is neutral-to-bearish in the daily chart, as per trading below a flat 20-SMA for a third consecutive day, and as the longer moving averages maintain their bearish slopes far above the current level. At the same time, technical indicators are seesawing around their midlines, without clear directional strength.

A slide through 1.1300 should favour a downward continuation towards the 1.1220 region, while below the latter, the pair could extend its slump below the 2021 low of 1.1185 to the 1.1160 price zone.

A strong static resistance level comes in at 1.1385, followed by the 1.1440 price zone, en route to the 1.1500 region.

EUR/USD sentiment poll

The FXStreet Forecast Poll suggest that EUR/USD will enter a selling spiral in the next weeks. Bears are a majority in the three time-frame under study, increasing as time goes by. The pair is seen averaging 1.1330 in the weekly perspective, and down to 1.1183 in the quarterly one. Those looking for sideways consolidation are quite a few, reflecting an increased selling interest.

In the Overview chart, the moving averages offer bearish slopes, with the momentum increasing as time goes by. In the quarterly view, most targets accumulate between 1.10 and 1.12, while a few analysts expect even lower lows.

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