Euro Pauses

[Ben Graham]

The euro seems to be in a state of flux, swinging from highs to lows. The rollercoaster ride for EUR/USD is driven not by expectations for the upcoming FOMC meeting but by events in Europe. The split within the Christian Democratic Union has cooled the bulls' fervor in the main currency pair, while the 1.8% increase in German industrial production in November has allowed buyers to mount a new offensive. The same applies to comments from European Central Bank officials.

Dynamics of German Industrial Production

The struggle between the "hawks" and "doves" of the Federal Reserve has so impressed the Governing Council members that they have recalled the varying opinions within the ECB. Christine Lagarde and Chief Economist Philip Lane said they felt comfortable with current interest rate levels. They were immediately met with criticism.

French Bank Governor Francois Villeroy de Galhau pointedly asked whether one can truly feel comfortable in an uncomfortable world. Yes, the degree of uncertainty has decreased, but it has not vanished. It cannot be said that the deposit rate will remain fixed at 2%. Only the target inflation rate may be fixed at 2%. The cycle of monetary policy easing could resume.

However, this was not agreed upon by Governing Council member Isabel Schnabel. The German economist noted that the markets are entirely correct in pricing in expectations for not a reduction but an increase in rates in the future. This will indeed happen, but not as soon as desired. Following such comments, yields on German bonds rose, pushing EUR/USD quotes higher.

Given the USD index's sensitivity to the yield spread between US and G10 debt markets, the American dollar is factoring in divergences in monetary policy. Therefore, a hastening of the Fed's easing cycle, particularly under pressure from Donald Trump, threatens to depress the greenback.

US Dollar Dynamics and Bond Yield Spread

US President Trump will stop at nothing to lower the federal funds rate to 1%. This move would reduce the costs of servicing the national debt and stimulate the American economy, even if only in the medium term. Problems with inflation will then rise to the forefront, but as Trump puts it, "after me, the deluge."

Thus, the schism is not only present within the Fed. The ECB can also boast of such divisions. While markets are confident in the conclusion of its monetary expansion cycle, the Fed is anticipated to take 2-3 acts of easing. This divergence forms the basis for the upward trend in the main currency pair.

Technically, the daily chart for EUR/USD shows short-term consolidation, indicating uncertainty. A break above the upper boundary near 1.1675 is a reason to increase previously established long positions. Conversely, if the euro falls below the lower boundary at $1.1625, it may indicate a shift to short-term sales.

The material has been provided by InstaForex Company - www.instaforex.com