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  • EUR/USD is consolidating just to the north of the 1.2250 mark after dropping about half a percent on the day.
  • USD is picking up in wake of the Democrat victory on Tuesday that handed them control of the Senate.
  • Tapering of the Fed QE programme will be a hot topic in 2021.  

EUR/USD is consolidating just to the north of the 1.2250 mark after dropping about 0.5% or roughly 60 pips on the day as a result of a resurgent US dollar. The dollar reaction to the Democrat’s Georgia election victories earlier in the week, which handed them control of Congress, has been on balance positive thus far. The pair was unresponsive to strong US ISM services and weekly jobless claims data earlier in the session, as well as to Fedspeak.

An intense debate as to the longer-term impact of higher US government spending in the months ahead is raging. The main bullish arguments go along the lines of further fiscal stimulus boosting US growth in 2021 and beyond leading to higher inflation and a more hawkish Fed. Indeed, the issue of when to start to ween financial markets off of the Fed’s ongoing QE programme already seems a hot topic of discussion amongst Fed members. Meanwhile, the major bearish arguments are along the lines of more fiscal stimulus leading to higher government and trade deficits and rising bond yields, which put more pressure on the Fed to print money to keep government borrowing costs low.

If the US dollar bulls fail to push DXY above the psychological 90.00 level, the bears may be re-emboldened to push the index back to fresh annual lows under 89.20 and will target the 2018 low at 88.25.

Fed QE tapering debate hots up

Amid all the political theatre of the past few days (the hotly contested Georgia election followed by the angry pro-Trump mob’s storming of Congress and ensuing fallout), updates from the US Federal Reserve have gone largely unnoticed.

The release of the FOMC minutes of the 15-16 December 2020 meeting hardly even generated the slightest ripple across markets. As a recap of the main points; all participants supported providing more detailed forward guidance on asset purchases and supported the adoption of the new qualitative outcome-based guidance. As a reminder, the FOMC said in its December statement that the pace of asset purchases would continue until substantial further progress has been made toward reaching the Committee’s maximum employment and price stability goals.

FOMC participants supported the idea of following a sequence similar to that of 2013-2014 when the time came to scale back the asset purchase programme. Meanwhile, some participants noted that the Committee could increase the pace or weighting of purchases towards those with a longer maturity if such adjustments were deemed appropriate (although there was little support to take such actions in the immediate future).

But while markets have largely been ignoring the theme of the Fed, the debate regarding when and how the FOMC might scale back its asset purchase programme has started to hot up. A number of Fed members have spoken on the topic, including over the last few hours;

On Thursday, FOMC member Charles Evans (President of the Chicago Fed) said any changes to QE would depend on how the recovery goes and if unemployment is coming down to 5% and the Fed is “making progress” (similar language to the most recent statement) on inflation, then the Fed may no longer need to do more QE. Evans added that he would advocate for the Fed using QE to “send a message” on the Fed’s commitment to its 2% inflation target if needed (i.e. if inflation remains persistently low, he would advocate more QE).

On Thursday, FOMC Member James Bullard (President of the St Louis Fed) said, seemingly reference when he would start to reassess the need for continued asset purchases, that he would assess where the economy stands once the unemployment rate had fallen into the 4% range.

On Tuesday, FOMC Member Loretta Mester (President of the Cleveland Fed) said she would like to see the Fed taper asset purchases by next year, though this would depend on the economy.

On Monday, FOMC Member Raphael Bostic (President of the Atlanta Fed) sounded the most hawkish on the outlook for the bank’s QE programme, saying that recalibration of the Fed’s QE programme could come in “short-order” if coronavirus vaccines and the economic recovery “takes hold”.

Tapering scenarios

Fed heavy hitters (Chairman Jerome Powell, Vice Chairman Richard Clarida and NY Fed President John Williams) are yet to give their take on when and under what conditions the Fed might taper its asset purchase programme, though one would imagine that they would stick to the script, i.e. just reiterate what was said in the FOMC’s last statement, to avoid any adverse market reactions.

But as the year progresses, the US is vaccinated against Covid-19 and the economic recovery accelerates and inflation picks up, this will inevitably be a key theme. Signs of a more hawkish Fed (i.e. one that will be willing to taper asset purchases more aggressively thus allowing real US bond yields to rise) is likely to be a positive for USD (and thus a negative for EUR/USD). Conversely, signs of a more dovish Fed (i.e. one that is more reluctant to taper purchases, thus keeping real US bond yields low) is likely to be a USD negative (and thus a positive for EUR/USD).

EUR/USD uptrend intact

EUR/USD continues to respect an uptrend that (roughly) links the 9, 21, 22, 23 and 31 December lows. The pair’s 21-day moving average at 1.2250 also helped keep it above this level. A break below this trend line, which would likely be signalled be a break below the 1.2250 mark, would open the door to a move back towards the 31 December low at just above the psychological 1.2200 level and then possibly on to the 1.2150 resistance zone.

EUR/USD four hour chart