Published: April 30th, 2021
While forex traders have been optimistic on the euro and its prospects against the greenback in recent weeks, Wednesday’s meeting of the US Federal Reserve’s open markets policy committee (FOMC) could have handed those bets a near-term setback.
By Thursday, however, it was clear that traders had, so far, read the Fed's policy runes correctly. The FOMC decided to leave its interest rate policy alone, sustaining a programme of near-zero interest rates and USD 120 billion in monthly bond purchases. Central bankers have been allowing the US economy to convalesce as it emerges from commercial lockdowns.
That support will now continue, at least for the near term.
The Fed’s decision came on the back of a new eight-week high for the euro-to-dollar exchange rate (EUR/USD). The pair reached 1.21 amidst a slew of speculation that it was on the way up.
Market Analysts at CaxtonFX told Reuters that euro sentiment has shifted of late, with traders becoming more bullish, EUR/USD reaching new two-month highs, and the European single currency appears to be on a footing for more upside.
Markets expected the Fed to keep its current settings unchanged and maintained a long-held consensus view that interest rates probably won’t go up for the foreseeable future. Market participants and policymakers all want to sustain a balanced view, Caxton says, taking care to nudge the economy back to full health while acknowledging that recovery is definitely underway.
For anyone betting on EUR/USD to keep its upward trajectory, Fed Chairman Jerome Powell continuing to make upbeat noises on the economy might signal that the Fed is prepared to start scaling back its robust quantitative easing programme before the end of the year.
If that happens, analysts say it will deliver upside relief to the greenback, which has dropped in value throughout April.
Forex strategists at UniCredit Bank told investors this week that the bank doesn’t expect any significant policy news from the Fed this quarter. However, it’s reserving judgement on potential future moves and may still call for prudence, favouring more range-bound activity for currency majors. Because of that, they think EUR/USD will stay stuck just below 1.21.
The pair has climbed by three per cent in the past month, reaching as high as 1.2116 at one point in early trading at the start of this week. The 2021 high for EUR/USD stands at 1.2348, which it hit on the sixth of January.
The Fed’s policy gathering happened in conjunction with the release of new flow and positioning data, both from the CFTC and financial institutions, that indicates traders are building up their euro exposure to take advantage of more expected upside.
FX Strategists at Rabobank told Bloomberg that net speculation positioning for the euro has jumped sharply. ‘The single currency looks to have been lifted at last by improving vaccine rollouts and prospects for a better-than-expected recovery in several EU countries.
EUR/USD spot price activity in the latter part of the week suggests that euro long positions could extend further, they added.
Against that backdrop, the Fed’s policy get-together happened in conjunction with a period characterised by large numbers of traders building EUR long positions. Suppose the Fed finds new positivity on the US economy and begins tapering the QE programme. In that case, it could bring a hawkish surprise for EUR/USD that negates expected gains for some recently-established bets.
Is that being too negative? FX analysts at Commerzbank explained in a note to investors that different rates of vaccine deployment between the major economies will naturally put more focus on relative monetary policy differences from one country to the next.
‘Given that context, the Fed’s meeting this week took on added importance, as will future comments by Chairman Powell on interest rates.
Commerzbank economists, and a majority of market analysts, believe the Fed isn’t ready to change course and conclude the expansionary monetary policy that’s kept America’s, and by extension, the world's, economy afloat under the pandemic.
‘The time isn’t right for big changes, meaning the central bank will live with higher inflation levels for the foreseeable future.
Of course, Washington policymakers will need to convince markets that the US central bank will hold the course and keep tolerating high inflation, even in the face of improving economic growth prospects. To keep the economy humming, the Fed will need to quiet speculation about any early scale-back of asset purchases or a sooner-than-expected lift in interest rates.
While forex markets and EUR/USD investors may cheer that approach, you can't please everyone in finance. Some analysts say the Fed is doomed to disappoint some market participants with its single-minded determination on quantitative easing. Those negatives notwithstanding, it seems Fed policymakers have, for now, cleared a path for further gains in EUR/USD, at least in the short-term.
At Goldman Sachs, analysts have released new research that tips EUR/USD to reach pandemic-period highs of 1.24 over the next three months. The Wall Street giant says that after the June meeting of the European Central Bank (ECB), Frankfurt is expected to cool the pace of bond purchases taking place in accordance with its quantitative easing programme.
If that happens, it will help the ECB narrow any gaps in any monetary policy with the Fed.
In a press release announcing the research findings, Goldman Sachs said recent stability in US rates has happened despite firm indications of growth. ‘Inflation data due to be released in the coming months might suggest that pricing in the funds-rate path has reached a local peak.’
Goldman is also telling traders that they should buy EUR/USD and watch for a rise to 1.25 in the coming weeks.