In order to look into the future, it is necessary to understand the reasons for what is happening now. The main drivers of the EURUSD correction were not the acceleration of European and German inflation to 4.9% and 6%, respectively, but the massive closing of positions in carry trade and doubts about the Fed's aggressive monetary restriction due to the Omicron variant of the COVID-19. And if Fed Chair Jerome Powell, in his speech to Congress, showed that the Fed is not going to back down from its plans to normalize monetary policy, then players on both sides continue to flee the market.
Not only are the euro and the yen characterized by low, often negative rates on debt denominated in them, they have also fallen in price significantly since the beginning of the year. It is logical that these monetary units were used as funding currencies in the carry trade. As soon as the news about the new strain of COVID-19 appeared, the players on both sides began to close longs on the assets of developing countries and currencies, whose issuing central banks were talking about raising rates and buying euros and yen. The result on the charts is EURUSD and USDJPY corrections. The latter turned out to be more impressive, as speculators inflated net shorts in Japan to the highest levels since the beginning of 2019.
Alas, the carry trade's support for the euro cannot continue indefinitely. This is a short-term factor that will soon become history. Even if Omicron turns out to be the deadliest of all known variants of the coronavirus, and the economies go into lockdowns again, the U.S. dollar will benefit from this as a safe-haven asset. It was so in March 2020, and it will happen now.
In contrast, the absence of severe symptoms and low mortality could turn COVID-19 into seasonal flu, reassure consumers and investors, and allow the Fed to tighten monetary policy with a clear conscience. Gaps in German and U.S. bond yields and interest rate swaps will continue to play into the bears' hands on EURUSD, as a result of which the major currency pair will easily restore the downward trend
Dynamics of EURUSD and interest rate differential swaps
While the Fed has abandoned the mantra of the temporary nature of high inflation, the ECB continues to adhere to it, which testifies in favor of divergence in monetary policy and puts pressure on the euro.
The key event of the week by December 10 will be the release of data on U.S. consumer prices. The indicator in November is capable of accelerating from 6.2% to 6.4%, core inflation - from 4.6% to 4.7%, which will be a pretext for an attack by the FOMC hawks. In just a few days, the Federal Reserve may decide to speed up the process of winding down QE.
Technically, the rebound from the resistance at 1.133 made it possible to earn a modest profit on the EURUSD shorts. If the statistics on the U.S. labor market for November are positive, the downward movement in the direction of 1.122 is likely to continue. If not, traders should still sell the pair on growth. Including the rebound from the resistance at 1.142.
EURUSD, Daily chart