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The ECB may have thought that its phrase about accelerating asset purchases under the €1.85 trillion emergency QE program had caused the euro to collapse, but in reality, investors are concerned about a very different event. The mess that FOMC officials are making in the financial markets could eventually turn into large-scale sales of stocks and bonds, which will force asset managers to buy up the US dollar with renewed vigor.
ECB President Christine Lagarde acknowledged that the rise in European bond yields is primarily due to belief in the strength of the US economy, and only then – in the recovery of the eurozone. She noted that in the context of increased debt levels, reaching up to 150% of GDP in the south of the eurozone, an increase in borrowing costs is an extremely undesirable event. The central bank will prevent this by increasing the pace of bond purchases. Although Lagarde did not give a specific figure, banks and investment companies predict that it will be about €80 billion per month, compared to the current volume of €60 billion.
Unlike the ECB, the Fed is not going to react to rising Treasury bond yields, which increases the attractiveness of US assets and contributes to the strengthening of the US dollar against major world currencies. This position is also increasingly unnerving investors. Indeed, according to research by the Federal Reserve Bank of Cleveland, at the current values of inflation and unemployment, the federal funds rate should rise above 1% in the first quarter of 2022 and above 1.5% in January-March 2023. The Federal Reserve does not hint at the normalization of monetary policy.
Accelerating inflation could provoke even greater turmoil in the market. Consumer prices in February rose to 1.7%, and that's just the beginning. Judging by the dynamics of the energy market, a significant acceleration of CPI should be expected in the next 3-6 months. If the Fed continues to remain silent, panic will lead to an increase in the cost of hedging currency risks associated with investments in dollar assets. An increase in this type of cost, as a rule, contributes to the strengthening of the dollar and the fall in EUR/USD quotes.
Trends in energy prices and inflation in the United States
Dynamics of EUR/USD and the cost of hedging currency risks
It should be noted that during periods of turmoil in financial markets, investors run to the US dollar, so the Fed should think three times whether it should stick to the old mantra of no worries about rising Treasury yields or change the rhetoric. If Jerome Powell focuses investors' attention on tightening financial conditions, this could calm the market and create a serious obstacle for the USD index to move upward.
Technically, on the daily chart, EUR/USD clearly works out the Broadening Wedge pattern. An upward correction followed by a rebound from the resistance near 1.199 allowed the formation of shorts. In my opinion, if the pair closes the week by March 12 below 1.193, it makes sense to increase short positions. A return above this level will indicate that the bulls are gradually coming to their senses.
EUR/USD, daily chart
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