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  • EUR/USD is consolidating close to 1.2300 as traders eye incoming event risk.
  • US politics (outcome of the Georgia Senate race) and data (ISM services PMI and NFP) are in focus.
  • The reflation trade appeared to weigh on the US dollar and help EUR/USD on Tuesday.

EUR/USD is trading close to highs of the day but has largely been unable to break back above the 1.2300 level. At present, the pair trades with gains of around 0.4% or around 50 pips.

Indeed, over the past few days, the pair has struggled to maintain 1.2300 status, failing to close above the big figure on Monday and last Wednesday. That implies that if there is a break above this level in the coming hours, it might well be more aggressive (perhaps some stops get triggered for example).

A break above the 1.2300 level would give the pair a clean run at the 1.2400 level, given a lack of any notable levels of resistance ahead of this point. 1.2400 formed solid resistance back in April 2018, and is likely to present a decent barrier again, but if this level was to go, a run higher towards 2018 highs in the mid-1.2500s is likely. Given the current bearish USD environment, as traders bet on an improvement in global economic and trade conditions as well as reflation in 2021 and beyond, many will be targeting this level.

EUR/USD four hour chart

Themes driving EUR/USD right now…

In terms of the major themes driving EUR/USD right now; Tuesday saw the US dollar weaken across the board versus its G10 and EMFX peers and this was the main factor driving EUR/USD higher.

Reflation trade bets seemingly contributed to the US dollars decline; commodities have rallied across the board on Tuesday (WTI and Brent up roughly 5%, spot gold up 0.3%, spot silver up over 1%, copper up nearly 3%). Meanwhile, US bond yields rose, particularly at the long end, with the 5s30s spread widening to more than 130bps, its highest since 2016. Meanwhile, US 10-year break-even inflation expectations have settled above 2.0% for the first time since Q4 2018.

ISM manufacturing PMI numbers out of the US also got traders talking about inflation, as the prices paid subindex shot to 77.6 from 65.4, only slightly below its 2018 highs of just under 80.0. Admittedly, supply chain issues had an impact, but the trend of rising prices according to ISM is undeniable (the prices paid component has risen 8 out of the last 9 months).

Markets appear to be betting on a return of inflation, which is not surprising given the tsunami of monetary and fiscal stimulus unleashed in 2020. This is seemingly being taken as a US dollar negative for the time being; the Fed’s current average inflation targeting policy essentially means they will have a higher tolerance for inflation reaching and even surpassing their 2% target for a time. In other words, higher inflation doesn’t necessarily mean tighter Fed policy as it might have in the past.

But the reflation narrative is likely to take a backseat in the minds of investors over the next few days amid a deluge of important market events, mostly revolving around the US (implying the USD side of the equation will continue to determine the majority of EUR/USD price action)…

US politics

Firstly, the result of the two Senate elections in Georgia are likely to be known by Wednesday morning. If the Republicans can cling onto at least one seat, they maintain a majority in the Senate and will maintain the ability to resist any significant additional fiscal stimulus packages or regulations on the Tech or energy industries that they do not like. If they cannot hold onto at least one of the seats, they will not be able to.

The market reaction to a Democrat upset is likely to be mixed. Strategists have bickered over whether optimism over further fiscal stimulus will be able to win out over fears of less favourable regulation and higher corporate taxes. However, the bond market reaction is much easier to predict; higher nominal yields and higher inflation expectations. This has proven a USD negative combination in recent days and might well drive EUR/USD higher.

US data

ISM services numbers for December will be in focus on Thursday, where eyes will again be on prices paid for any further evidence of inflation. The US services sector is more exposed to the virus and lockdowns and is unlikely to have performed as well as Tuesday’s manufacturing report. Official December jobs numbers will then be reported on Friday.