Title: EUR/USD Weekly Forecast: Fed Weakness Sparks Euro Upside Momentum
Author Credit: Adapted from an article by Currency News, originally published on August 18, 2020.
Overview
The Euro to US Dollar (EUR/USD) currency pair recorded strong gains over the past week, supported by signs of economic resilience in the Eurozone and increasing market expectations of Federal Reserve caution that is weighing on the US Dollar. While broader market risk appetite also contributed to the Euro’s strength, the key driver remains the divergent monetary policy outlooks between the European Central Bank (ECB) and the Federal Reserve.
The Euro begins the upcoming week on a firmer footing, benefiting from favorable sentiment. Although caution remains due to external geopolitical risks and uncertainty over the global economic recovery path, fundamental factors currently tilt in favor of the Euro. Market action will focus on commentary from Federal Reserve officials, incoming US data, and signals from the European Central Bank.
Last Week in Review
EUR/USD strengthened notably across the week, closing nearer to 1.1850, bolstered by:
– Dovish commentary from Federal Reserve officials indicating a willingness to keep interest rates lower for longer.
– Better-than-expected Eurozone economic data, particularly from the German industrial and services sectors.
– Improving risk sentiment globally, reducing demand for safe-haven currencies like the US Dollar.
– Continued weakness in US economic indicators, particularly labor market data, which is raising concerns over the sustainability of the US recovery.
Economists point to the Fed’s ongoing commitment to a dovish policy stance as one of the most influential factors dragging down the Dollar. Meanwhile, the ECB is signaling stability, with fewer shifts in forward guidance, bolstering confidence in the Euro.
Federal Reserve Policy Outlook
At the heart of the Euro’s weekly strength was a growing realization among traders that the Federal Reserve is unlikely to shift toward monetary tightening in the near term, especially given subdued inflation expectations and labor market constraints.
Key developments supporting that view included:
– Fed officials, including Chair Jerome Powell, reaffirming the central bank’s willingness to maintain substantial monetary support.
– A consensus within the Fed that interest rates will likely remain at near-zero levels until significant labor market improvements materialize.
– Rising speculation that the Fed will adopt average inflation targeting, allowing inflation to overshoot its 2 percent target for a period before adjusting policy.
Market reaction to these developments was swift. US Treasury yields dipped, and the Dollar Index (DXY) fell to multi-month lows, reflecting eroding demand for US-denominated assets.
Eurozone Resilience and ECB Signals
On the other hand, Eurozone data have generally surprised to the upside. Notable indicators include:
– German ZEW Economic Sentiment and industrial production figures pointing to stronger underlying momentum.
– Eurozone composite Purchasing Managers’ Index (PMI) remaining in expansionary territory, suggesting steady economic recovery.
– Limited indication from ECB officials that further easing is imminent, fostering Euro stability.
Unlike the Fed, the ECB appears to be taking a wait-and-see approach, emphasizing transparency and maintaining existing policy frameworks. ECB officials have been careful not to talk down the Euro despite its appreciation, which is interpreted as a confidence signal by traders.
The week’s macroeconomic releases suggest that, while the Eurozone continues to face challenges, particularly in Southern Europe, the economic divergence between the US and Eurozone appears to be narrowing in the Euro’s favor.
Market Reaction and Investor Sentiment
Market sentiment played an essential role in the EUR/USD uptrend. Broader investor optimism was fueled by:
– Progress in COVID-19 vaccine development around the world.
– Easing tensions in certain geopolitical hotspots, which lifted equities and commodities.
– A weakening of the US Dollar’s safe-haven appeal amid improved global growth expectations.
With risk-on dynamics favoring currencies perceived as cyclical or stable, the Euro drew increasing interest. The declining attractiveness of the Dollar, exacerbated by falling real yields in the US, rendered EUR/USD
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