Inflation in the United States, which has jumped to almost a 40-year high, has moved from the field of economics to the field of politics, since it is no longer only exciting the minds of FOMC officials, but is bringing down the ratings of the US president and his team.
Last week, US President Joe Biden said that the most important task to ensure that prices are not fixed at a high level lies with the Federal Reserve. He also welcomed the upcoming increase in interest rates.
At the same time, the country's Finance Minister Janet Yellen said that the growth of inflation is the main political problem.
Apparently, Fed Chairman Jerome Powell is not going to disappoint either Joe Biden, who retained his post as head of the Fed, or Yellen, who is confident that the central bank will take the steps necessary to reduce inflation during 2022.
Following the results of the January meeting, which ended on Wednesday, the Central Bank made it clear that it would most likely raise interest rates in March, and confirmed its readiness to stop buying bonds in the same month before starting to reduce the balance sheet.
With these steps, the central bank intends to begin the transition from a soft monetary policy launched in the era of the pandemic to the fight against high inflation.
"This will be the year during which we will steadily move away from the highly stimulating monetary policy used to overcome the economic consequences of the pandemic," said Powell.
At the press conference, the Fed chairman also repeatedly stressed the fundamental strength of the economy and the stability of inflation and refused to rule out a more aggressive tightening of policy as necessary.
"We need to be, as I have already mentioned, agile in this matter. This time the economy is completely different," said Powell.
The slogan under which he last led the rate hike cycle was "gradual." However, now it seems that everything will be different.
Powell stressed that the current period is not at all similar to the end of the last expansion, since inflation is much higher. This implies that they will need to move faster than then. As a result, the risks are shifted by more than four (4) rate hikes this year, according to Bank of America.
Some analysts were not slow to take advantage of the fact that during yesterday's speech, the head of the Fed did not rebuff market expectations regarding the possibility of raising the key rate in March by 50 basis points at once.
"We now expect a 50 basis point rate hike at the Fed's March meeting, followed by three 25 basis point increases in May, June and July," Nomura strategists said.
BNP Paribas analysts predict six increases in the federal funds rate by 25 basis points in 2022 compared with four earlier and believe that the target range will be 2.25-2.50% by the end of 2023, which is 25 basis points higher than the previous forecast.
"Our new baseline scenario, assuming six increases this year, challenges our optimistic outlook for US stocks," they said.
Fed funds rate futures showed that by December, traders had raised expectations to as many as five rate hikes, after previously fully estimating only four.
The hawkish comments of Powell was driven by the dollar rally and put pressure on global stock markets.
"While reports from FOMC members in the run-up to this meeting meant that the turnaround should not have come as a surprise, risk appetite declined as the press conference progressed. Powell, and the degree of the central bank's commitment to act in conditions of significant inflationary pressure has become obvious," ANZ analysts said.
After rising more than 1% in the first half of the day, the S&P 500 index closed in the red zone on Wednesday, dropping by 0.15%. At the same time, the greenback grew by more than 0.5%, reaching the highest levels since December last year in the area of 96.47 points.
On Thursday, the dollar continued to strengthen against its main competitors, including the euro, and updated multi-month peaks above 97.20 points.
Further, the resistance is at 97.80 (high on June 30, 2020) and 98.00 (round mark).
In the short term, the greenback will remain constructive while staying above the 4-month support line at 95.45.
According to a number of experts, the USD now has one road – up, as it becomes more obvious that this year will not be a year of stocks for global markets, and also given the Fed's intention to actively fight high inflation.
The hawkish attitude of the Fed supports our forecast, which assumes further growth of the dollar this year and pressure on risky assets and currencies, MUFG Bank notes.
Powell did not rule out a sharper tightening of monetary policy, paving the way for a likely rapid rise in the dollar to new highs, Westpac strategists believe.
They expect a rapid USD sprint to 99-100 in the next few weeks.
"The Fed will almost certainly raise rates in March and will soon begin to normalize the size of the balance sheet. We believe that the regulator will raise rates four times this year, while there is a possibility that the tightening will be carried out at a faster pace, especially by the end of the year. In this regard, we expect a further decline in the EUR/USD pair," Nordea analysts noted.
The main currency pair suffered heavy losses on Wednesday. The day before, it broke through the support of the 2-month uptrend line at 1.1295 and closed below this mark.
On Thursday, the EUR/USD pair remained under bearish pressure and fell to lows since June 2020 near 1.1135.
Today, the economic calendar for the eurozone is empty, and the main driver for the pair is the dynamics of the dollar.
The greenback continued to grow on Thursday across the entire spectrum of the market, playing back the results of the January FOMC meeting, as well as positive statistical data for the United States.
According to the Ministry of Commerce of the country, in the fourth quarter of 2021, the national GDP, according to the first estimate, increased by 6.9% year-on-year, while analysts expected the indicator to grow by 5.5%.
A separate report showed that the number of initial applications of Americans for unemployment benefits for the week ended January 22 decreased by 30,000, to 260,000. The indicator coincided with the forecasts of experts.
If the EUR/USD pair fails to recover above the 1.1200 level, the next support may appear at the round levels of 1.1100 and 1.1000.
The main currency pair has been in the range of 1.1200-1.1400 since November 2021, but now it may decline and move to a new range of 1.1000-1.1200, TD Securities believes.
"Our target for EUR/USD at the end of the first quarter of 2022 is 1.1000, and at the end of the second quarter – 1.0800," ING strategists said.
"The ECB continues to firmly adhere to the mantra that a jump in inflation will not force it to hurry up with raising rates. If there are no significant changes in this issue, the EUR/USD pair will remain under pressure. In addition, the European currency may become a victim of the escalation of tensions around Ukraine and the associated prospects for interruptions in energy supplies or, at best, further growth in energy prices in the Old World. This will hit regional industry and consumers, but will play into the hands of the dollar due to its geographical and energy independence," they added.
Although the medium-term technical picture does not bode well for the euro, some analysts say it is too early to draw far-reaching conclusions, since the speed with which the Fed will tighten policy will be the main factor determining the attitude to risk in the coming months.
Following the results of the January FOMC meeting, Powell said that the Fed's policy course is now very uncertain.
"This time we have not made any decisions regarding the policy path," he said.
"The US central bank does not assume obligations on the size or frequency of rate hikes, as well as on the timing of the balance sheet reduction. We think that this gives him a bit of room for maneuver as to how quickly and at what speed he wants to normalize monetary policy," the experts of Invesco noted, adding that the actions of the regulator will depend on the upcoming economic data.
On Wednesday, Powell said that the Fed intends to start raising rates in March to tame rampant inflation.
However, an increase in the key rate at the next FOMC meeting will be possible if the US labor market continues to grow, since if the US employment figures for January are negative, then the Fed members will look pale.
Thus, putting in quotes more than four federal funds rate hikes in 2022, the markets are likely to greatly overestimate the hawkish attitude of the Fed.
In addition, the tools of the US central bank are limited, and the national economy is unlikely to be able to easily survive high interest rates.
If the rates on 10-year US government bonds rise to the level of the beginning of the century, then servicing only government debt instead of 1.5% of GDP will reach about 5%.
Therefore, despite the 7% inflation, the Fed itself most likely does not expect the rate to rise above 1.5% this year.
There is one more nuance.
In 2008, the Republicans lost the presidential election, including because the US central bank failed to adequately respond to the emerging mortgage crisis. Democrats may also lose the November congressional elections this year if the Fed overdoes it with tightening monetary policy.
However, Powell has repeatedly demonstrated the ability to keep abreast and show "sensitivity" to the political moment, both under Donald Trump and under Joe Biden. Assuming that the Fed will try to avoid major excesses in the financial markets, at least this year, the dollar rally should be interrupted relatively soon and turn into a more significant correction compared to the one that happened recently and led to the USD index pulling back below 95.00. In such a scenario, the EUR/USD, which has room to go down as far as 1.1000, may avoid a deeper drawdown.
The major currency pair has already sunk to 19-month lows.
Further decline seems likely in light of the ongoing price action.
Additional losses for the pair are guaranteed as long as it remains capped by the 4-month resistance line at 1.1340.
Immediate support lies at 1.1105 followed by 1.1060 and 1.1015.
The initial resistance is noted at 1.1185, and further - at 1.1220 and 1.1260.
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