For the last 10 years, EURUSD trend has been consistently on the downside. This is due to years with negative interest rates which the European Central Bank has maintained, hoping to stimulate economic growth. Prior to 11th June 2014, EURUSD ranged between 1.25 and 1.60 and only touched the bottom of this range once in February 2018. Trend continued downwards, with USD strength pushing the rate to 1.09 in 2019 and early 2020 after the Federal Reserve continued increasing rates, further widening the interest rate differential.
When COVID hit, monetary policy shifted aggressively to bond buying and lowering rates. This assisted in protecting employment and businesses and kept the wheel turning until vaccines were distributed to the masses. The ECB had no policy firepower left as the fixed rate MRO was already at 0% and deposit facility at -0.50%, meanwhile in the US, an aggressive cut of 1.50% took place in a month. Both central banks turned to their governments to also issue policies to assist the economy in not drying up, stall and break.
EU coordinated for the first time in history to issue joint debt (NGEU) and the US passed several bills and acts amounting in trillions of dollars. ECB engaged in several programs, PEPP, TLTRO, PELTROS to make sure that sufficient liquidity is made available to banks and businesses.
This cheap and readily-available money pushed equity and commodity markets to all time highs and yields to all time lows. From last year, March 2020 to June 2021, EURUSD moved upwards from 1.06 to 1.22 (+15% move). We can expect to see further upside in EURUSD in Q4 this year and early next year, however this is dependent on how several fundamental and technical factors play out.
With latest inflation readings topping 5% for US and 2% for EU, market participants are worried about an onset of hyperinflation and whether central bankers have been slow to react. Further reading on central bankers’ reaction to inflation flare up can be found here. However, it should be noted that indeed this sudden rise stemmed mostly from energy commodities particularly Fuel Oil (+50.8% 12-month change) and Gasoline (+56.2% 12-Month Change). We should expect inflation to stabilize to around 2% with growth rates and unemployment to continue along the economic projections laid out by the Fed reserve members and ECB staff respectively.
For next quarter (Q3), we expect EURUSD to pullback around the 1.2 levels as inflation readings might still scare investors. However, we expect this pullback to be short-lived as long as GDP growth and unemployment readings improve for both US and EU. Commodity prices and by extension, inflation, would stabilize as supply chains adjust to the reopening of the global economy. Additionally, as COVID cases continue to subside, EUR would continued gaining as foreign investors would seek equity opportunities in the EU and global risk on sentiment gains. This outlook is maintained as long as the FED does not hint to tapering or interest rate increases.
The Black vertical dotted lines represent the third quarter, that is, July to September. Purple box is where we anticipate the price will stabilize around.