FX.co ★ Outlook for USD, EUR, and GBP: Fed prepares to act while ECB stays cautious

Last week, FOMC member Richard Clarida unveiled several key factors that will determine the Fed's policy in the near future. He believes that the Fed will continue adjusting its monetary policy in accordance with expected inflation and not actual inflation. Clarida also highlights that once the Fed starts its hiking cycle, he intends to monitor the Taylor rule with no emphasis on the labor market.

This announcement may signal the Fed's intention to launch a new policy while inflation and unemployment rates are still lagging behind the target levels. Inflation expectations are already outrageous: the 5-year TIPS yield, which helps measure inflation expectations, has already reached an 8-year high and keeps gaining momentum.

Other FOMC members mentioned earlier that a refusal to consider the unemployment rate also implies a refusal to follow the Phillips curve.

Markets should be prepared that the Fed may start its rate hike cycle unexpectedly. The likelihood of this scenario will push the US dollar higher. The period of the US dollar weakness is likely to end soon, unless the new US administration tries to solve the problem of rapidly growing budget deficit.

EURUSD

The euro continues to trade mixed and neither resumes the uptrend nor starts the correction. The existing drivers are not enough, and yesterday's meeting of the ECB did not add any clarity.

The ECB monetary policy remained unchanged, and Christine Lagarde chose words carefully, not allowing the euro to change direction. Such cautiousness may reflect the uncertainty in the regulator's forecast as the accompanying statement excluded any references to exchange rate.

The outcome of the meeting made it clear that the regulator is not going to expand the PEPP. This is obviously a bullish signal for the euro. We can also assume that the volume of asset purchases will gradually decrease. Most likely, markets will no longer see any peak volumes.

The indicator signals are inconsistent. According to the European Commission, Consumer Confidence Index fell to -15.5 in January from -13.8 in December. This is a bearish signal, especially together with zero inflation growth, which points at weak consumer demand.

At the same time, the ZEW index, which reflects investor sentiment, rose from 54.4 to 58.3, indicating a recovery in business confidence. Markit has also published mixed data today. According to it, activity in the services sector fell to 45 from 46.4. The manufacturing PMI is slightly worse. So, it is too early to stop financial incentives.

At the moment, EUR/USD is unlikely to return to 1.2350. The US dollar will need to react to a number of bullish signals. So the pair will continue to trade in the sideways channel, tending to hit its lower boundary. The resistance is located at 1.2200/20, while the stop loss is set slightly higher. It is worth opening sell positions from the current levels with the nearest target at 1.2055.

GBPUSD

Despite downbeat economic data, the pound has hit a new local high and looks much stronger than the euro. The GfK Consumer Confidence Index dropped to -28 in January from -26 in December. GfK Group's view of the economic situation remains rather gloomy.

As predicted, retail sales rose in December but failed to meet analysts' expectations. The Markit Manufacturing PMI declined from 57.5 to 52.9, while the services sector collapsed to an 8-month low of 38.8. Obviously, such business activity indicators signal slow economic recovery.

Such economic downturn may be explained by COVID-19 restrictions. Anyway, the fundamental support for the pound is weak. Its short-term rise can be a speculative reaction to a new trading system being formed after Brexit. In other words, the pound benefits from the UK's intention to readjust the system of international agreements in its favor.

As the saying goes, time will tell. The pound remains positive and may try to resume an upward movement. The strategic target of 1.4300/50 is still relevant. Recommendations for the short term remain the same: buy on pullbacks with the nearest support level at 1.3610/20.