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On the euro’s potential: Omicron optimism will provoke a jump to $1.30

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The EUR/USD pair has entered a bearish phase again, the euro has passed the 1.1400 mark. The yield of treasuries has jumped and will grow even more. Dollar bulls have revived, as expectations for a Federal Reserve rate hike are growing almost daily. At the end of the year, the rate is set at 1.07%. At the same time, three weeks ago, the market was laying at 0.82% at the end of December. It turns out that during this time, another 25 bp was added to the expectations for the rate, or one standard increase.

Now the opinion is being actively introduced to the masses that the Fed has delayed tightening policy – it did not respond to inflation in a timely manner. Even the current hawkish mood will not be enough to neutralize the formed trends in inflation. This means that the central bank can tighten policy even more rapidly.

To restore the markets’ confidence and show how serious the central bank is, it is necessary to raise the rate in March by 50 bps at once, billionaire Bill Ackman believes. JPMorgan is convinced that the Fed will raise the rate not four times, but more. Such figures are called six or seven times before the end of the year.

How can the dollar not strengthen against such a background. The euro’s growth looks more like some kind of misunderstanding or at least a temporary correction that has ended. The EUR/USD pair should return to the area of 1.1200-1.1300 or lower.

The support of 1.1370 was crossed today, which means that the fall will increase. The next support is located at 1.1347. In the longer term, the outlook will remain bearish as long as the euro is trading below 1.1700.

On Tuesday, EUR/USD traders focused on ZEW sentiment indicators for Germany and the eurozone for January. They are expected to be crucial for determining euro sentiment by the end of the week.

The index of investor confidence in the German economy rose to 51.7 points from 29.9 points in December. The markets expected growth only up to 32 points. Meanwhile, the index of current economic conditions sank to -10.2 points from -7.4 points in December – stronger than forecast. The same indicator for the eurozone also significantly exceeded the forecast – growth to 49.4 against 26.8 in December and the forecast of 29.2.

“The economic outlook has improved significantly since the beginning of the new year. It is likely that the phase of economic weakness from the fourth quarter of 2021 will soon be overcome. The main reason for this is the assumption that the incidence of COVID-19 will decrease significantly by the summer,” ZEW commented on the situation.

Statistics are strong, and in general, the euro may continue to grow on Omicron optimism. However, at the moment, other factors outweigh the dynamics of futures on US indices and the growing yield of 10-year bonds. The yield reached 1.85% for the first time since January 2020. Further, as expected in the Societe Generale, it will continue to grow in the direction of 1.97%.

The dollar index continues to recover above the 95.00 mark on Tuesday. If the bullish mood increases, the indicator can reach the resistance of 95.76 and further to 95.81.

If we talk about the impact of tightening monetary policy in the United States, then this is, of course, a positive for the dollar in the long term. The fair exchange rate of the EUR/USD pair has already sunk to 1.2500, whereas last year, based on the difference in rates, it was at the level of 1.3100. If the Fed goes for a bigger rate hike this year, and the yield of treasuries strengthens growth, the fair euro exchange rate may decline to 1.2300.

Not everything is so bad for the euro, because it does not cancel the dollar’s decline. Deviation from a fair exchange rate may occur not only in favor of the US currency. The situation with Covid seems to be getting better. Europe will benefit more from the end of the pandemic than the United States – this is obvious. First, the dollar acted as a protective asset during the pandemic. Secondly, the eurozone has a great potential for post-pandemic recovery in terms of the service sector.

It would not be surprising if, under such circumstances, the euro rises above 1.3000.

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