At the beginning of January currency pair EURUSD peaked at 1.2350, after which the selling pressure increased. Since the middle of last month, the pair has been looking for support at the 50-day simple moving average, but slipped below it towards the end of January. A decline under this mark still looks like an alarming new stage for the euro. Let’s look at several scenarios.
Is the pressure on the dollar over?
According to the first scenario, the pressure on the dollar reached its climax by the beginning of the year, after which it turned to growth. Before that, we saw three impulsive growth waves: May-June, July, November-January. Each of them was followed by a consolidation or shallow pullback. However, by the beginning of February EURUSD reversal appeared, mirroring the previous rally with a steady trend to lower and lower intraday highs and lows. Currently, at the time of this writing, EURUSD is testing the 1.2000 area, retracing back about half of the gain from November to January.
Technically, even more important than 1.2000 support line for the pair is the area 1.1930-1.1950… At these levels, the pair was decisively barred up last August, and a breakout of this area in November marked a powerful rally and a temporary surrender of the bears. The failure of this line of defense (this time by the bulls) will be a signal for a prolonged decline in EURUSD and will call into question the assumptions about the start of a long-term decline in the dollar.
1.1000 on EURUSD by the end of the year
The pressure on the dollar in 2020 was driven by a more alarming picture of the spread of the pandemic, which required more stimulus and hurt the dollar. Now the wheel has turned: Europe is stalled with vaccinations, and the number of new cases stubbornly does not want to decline.
In addition to this, the adoption of the support package is being delayed in the United States, which means that fewer dollars circulate in the economy than the markets predicted earlier.
If the situation continues to be the same, EURUSD quotes may return below 1.1000 already before the end of this year. That is, the dollar will completely return to the same levels where it was before the start of the pandemic.
However, this scenario still seems to be a backup rather than a primary one. EURUSD has lost its growth momentum along with the slipping of the support package in the US, but still lawmakers there do not refuse to stimulate the economy and checks to the population.
US debt and inflation
Solving some problems, the United States is strenuously accumulating others. Worse, direct distribution of money to the population is a powerful pro-inflationary factor, because buyers do not spend money on paying off excessive debt, as after 2008. Americans are doing much better now with personal debt.
But things are worse with debts at the state level. The debt to GDP ratio will skyrocket to highs since World War II. In the postwar years, the United States “blew” debt through inflation and financial repression (maintaining bond yields). The process went especially quickly with the abandonment of the gold standard. Buying up US government bonds and contributing to the fall in the yield of 10-year government bonds well below 2%, the Fed is similarly reducing the real amount of government debt.
Changing strategy and targeting 2% over an extended period of time is the legal basis to keep inflation above the target in order to blow off some of the debt burden from the government.
It is not profitable for Americans to maintain a growing dollar, as this suppresses inflation and reduces international competitiveness.
How to convince the whole world?
At the same time, the United States needs to convince the whole world that it is not reasonable to throw Treasury bonds into the market at a time when the country’s Treasury needs to place abnormally high volumes of government bonds. It would be most reasonable for them to convince the whole world that there is nothing more reliable than a long-term investment in the dollar, thereby ensuring the demand for new issues.
This makes the dollar’s rise short-term. Perhaps episodic. The dollar may recover to 1.1750-1.1950, parallel to the placement of the bond. However, restoring a normal life will raise the question of how to live with the accumulated legacy of the pandemic.
Europe in this case looks much less burdened. In addition, it does not wage trade wars with China, which is also favorable for the interest in the euro as a reserve currency from the NBK.
According to this scenario, the corrective pullback of EURUSD in the coming days and weeks to the 1.1800 area will be followed by a new growth impulse for the euro with an initial target of 1.2500 by the middle of the year, 1.3000 by its end.