The euro lost some of its positions and failed to compensate for them during yesterday's trading. Even despite the profit-taking observed at the end of last week against the US dollar, pressure and risks from the new strain [Omicron] of the coronavirus, force investors to stick to safer assets.
Recall that during their last meeting, Federal Reserve officials were ready to begin cutting the bond-buying program at a larger pace in order to keep inflation in check. Now that they have inflation data at their disposal, most likely, more serious changes can be expected during the last December meeting of the open markets committee this year. Most likely, the committee will announce another reduction in the rate of asset purchases, but the moment will become more important when the central bank will resort to changing the interest rate on federal funds. This is expected to happen much earlier than politicians anticipated in early fall.
There is a theory that if inflation continues to rise further, and there are no obvious reasons for its slowdown, the Federal Reserve System may raise rates even before the complete reduction of the bond purchase program, as the Bank of England intended to do this summer, but then abandoned this idea.
Commerce Department data for October showed prices have risen 5% over the past year, the highest inflation since 1990. The current baseline scenario is that the Fed will announce a two-fold reduction in monthly bond purchases, and the program will end by the end of March, rather than in the summer, as previously thought. As I noted above, at its last meeting, the FOMC left interest rates close to zero and announced a $120 billion monthly cut in bond purchases under the program.
If everything happens as expected, it will not be a significant shock for the market, since traders began to lay this scenario back in October - which, in fact, led to such an upward trend in the US dollar against a number of risky assets. An earlier cut in the program will give officials the opportunity to raise interest rates earlier if necessary to contain inflation. Back in September of this year, Fed officials were equally divided over the need for a rate hike next year or in 2023.
In his recent speech, Fed Chairman Jerome Powell said that policymakers will use tools both to support the economy and maintain a strong labor market, and to prevent inflation from rising. It was clear from the minutes of the meeting that many continue to expect that the inflation rate will decrease significantly during 2022, while among them there are those who look at inflation as more stable. Even after the October CPI data, there was already a group of supporters of accelerating the process of a larger cut in the bond-buying program, but on the condition that prices continue to rise.
Now there are clearly more of them, and ahead of us are data for November, which will "dot all the i's." This Friday we will also look at the data on the American labor market, where things are doing very well. If the number of jobs grows, the Federal Reserve, along with its chairman, Jerome Powell, will have no serious reasons for the delay.
Let me remind you that the outgoing Fed Vice Chairman Richard Clarida, who will be replaced by Lael Brainard, Governor Christopher Waller, President of the St. Louis Fed James Bullard, and the head of the San Francisco Fed Mary Daley recently announced that it would be advisable to discuss accelerating the process of curtailing the current program at the next FOMC meeting on December 14-15.
Experts expect that with the latest data pointing to GDP growth in the fourth quarter to reach 6.5% on an annualized basis, more officials will take advantage of this moment and still announce a cut in measures to support the economy.
The direction of the European currency also depends on its actions in relation to monetary policy. Of course, the fact that the euro collapsed so much against the US dollar plays into the hands of the regulator, since in the future it will affect exports and bring a good percentage in the formation of GDP. However, the future of European Central Bank stimulus is not becoming clearer ahead of the December meeting.
It is now known for sure that the current Pandemic Emergency Purchase Program (PEPP) will be phased out as planned, but it will remain available for reactivation if necessary - such a need may be caused by the new coronavirus strain Omicron.
At the moment, it is difficult to say what the consequences of the new strain will be. Scientists said last week that it will take them several weeks to thoroughly study it. On Friday, the World Health Organization called the omicron strain a "dangerous option." And while scientists continue to investigate this option, the large number of omicron mutations is alarming. According to preliminary data from WHO, this strain has an increased risk of re-infection.
However, Dr. Angelique Coetzee, the South African physician who first discovered the omicron variant, just recently made a statement describing Omicron's symptoms as "extremely mild." This slightly eased investors' fears about the possible resumption of restrictions and the introduction of lockdowns during the Christmas and New Year holidays.
This strain was reported to originate from South Africa. And now, cases of this variant have already been recorded in the UK, Israel, Belgium, the Netherlands, Germany, and Italy. No cases have yet been recorded in the United States. But this has heightened worries to other countries across the globe, forcing them to restrict entry from South Africa.
Going back to central bank policy, in just three weeks, officials from the European Central Bank will meet in Frankfurt for the last time this year to discuss the details of monetary policy. By that time, the situation with the new strain of coronavirus will be more or less understood, and most likely it will play an important role. The purpose of the meeting will be to pave the way for post-crisis stimulus to provide sufficient support for yet another fight against coronavirus - without risking too much inflation. Officials are ruling out an interest rate hike in 2022, but want to retain the ability to respond quickly to shocks.
Despite the growing threat from the new strain, the statements of ECB politicians are beginning to take on a hawkish tone. ECB Board member Isabel Schnabel said recently that inflationary risks are "shifted upward."
More and more officials agree that the PEPP will indeed be halted on schedule in March. This intention has been highlighted in the ECB minutes from its last meeting. Now ECB members must decide whether they should step up the regular asset purchase program that was in place to support the economy even before the coronavirus pandemic, and to what extent they should maintain it.
The fact that ECB representatives have already started talking about the need to be more careful about stimulus programs gives support to the euro and makes it more attractive, especially at current prices.
Buyers of risky assets coped with their task and kept the support at 1.1260 yesterday. This preserves the upward correction in the euro, but the weekly highs need to be updated - without this, it is problematic to count on a larger rise. To do this, they need to get out above the resistance of 1.1315, which will allow them to reach the next level of 1.1360. After that, it will be quite easy to climb to 1.1420. If the pressure on the trading instrument increases, then the breakdown of 1.1260 will quickly bring the pair back to 1.1220, and there it is a stone's throw to the lows of the month around 1.1185.
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