FX.co ★ EUR/USD: US dollar holds steady, euro plays with markets, Fed hints about tapering roadmap

The greenback hit a nine-month peak as the Federal Reserve hinted that its asset purchasing program reduction was just around the corner.

The FOMC meeting minutes showed that the Fed's officials almost agreed to set the stage for the QE tapering beginning this year.

In this regard, the annual Jackson Hole Symposium appeared to be a venue for the regulator to begin preparing the markets for a new policy. However, the largest one-day drop in the USD since May and the new highs for the S&P 500 Index before the Symposium indicate that investors are pushing back their expectations for tapering.

Last Friday, markets experienced an improvement in their sentiments, resulting in risky assets surging and the safe-haven dollar plunging.

Furthermore, Robert Kaplan, President and CEO of the Dallas Fed, added fuel to the fire. He had earlier insisted that the number of bonds to be bought out might soon be reduced, and now he admitted that delta variant outspread was likely to make him reconsider his views in that regard.

Also, positive news from China boosted the market sentiment even more. The country with the world's largest population reported no new domestic coronavirus cases on Monday.

The safe-haven dollar appeared under selling pressure after the US Food and Drug Administration (FDA) completely approved the Pfizer/BioNTech COVID-19 vaccine.

Mass immunization could help defeat the disease that wreaks havoc in America. It may imply a strengthening of economic growth around the world.

On Monday, the greenback retreated even further from the multi-month peaks seen at 93.70.

At the same time, even the IHS Markit data published the day before, showing that business activity in the US slowed down for the third month in a row in August, did not hinder the S&P 500 index in renewing its all-time 4,490 high.

Market participants continue to follow the "the worse, the better" principle, believing that it can force the Fed to postpone the tapering signals.

In addition, according to experts, with the current level of liquidity, any news ultimately pushes to buy the assets.

"The tidal wave of liquidity is so powerful, so vast, that the buy-the-dips mentality is the dominant force right now," CIBC Private Wealth Management experts noted.

The market still has enough positive aspects including the Fed's ultra-soft monetary policy to buy out short deals.

However, analysts warn that this correlation can weaken at any time, and it may be risky to rely on it as a permanent trading strategy.

The fact that the market is slightly ahead of the economy is also of concern.

Although the greenback is experiencing some pressure coming from the growth of stocks, since June it has maintained an uptrend while strengthening purchases during a downtrend.

These two trends rarely coexist for long, so it's worth watching closely for which one will eventually prevail.

On Tuesday, the dollar was showing little change against its major counterparts. Investors appear to be refraining from making bets on the USD decline for now after it suffered its most tangible daily losses since May.

On Monday, the greenback declined 0.5% touching support at 93. The last time the USD index held this level was in November last year.

Demand for the dollar as a safe-haven asset is supported by ongoing global risks, including simmering Sino-US conflicts and fears of a slowing global economic recovery.

In addition, market participants wonder whether the Fed will announce a reduction in asset purchases already at the September meeting. The minutes of July's Fed meeting show that the regulator allows the beginning of the tapering already this year. Although it was also voiced that the beginning of the next year is more suitable for such measures.

Other leading Central Banks have recently eased their policies. In particular, the Reserve Bank of New Zealand failed to raise rates, citing risks of a slowdown in the national economy due to new lockdowns. Meanwhile, weak economic data for July, including inflation and retail sales, derailed the Bank of England's tighten policy plans.

It remains unclear whether the Fed will follow suit.

Investors will receive more details on the economic implications of the new delta variant outbreaks in the US in the coming weeks. Also, before the September FOMC meeting, there will be another important report on the US employment situation for August. After that, the Fed will have two more meetings in November and December in 2021, and if the regulator chooses a dovish approach, it may wait a few more weeks before giving clear comments about the timing of QE tapering.

"The idea that the Federal Reserve is heading to a taper at some point this year is well-publicized, particularly after the July FOMC minutes, and therefore presumably already embedded in the price of the USD," economists at HSBC said.

The HSBC experts think that Fed Chair Powell's speech at the annual Jackson Hole Economic Symposium, which is scheduled for 26-28 August, could signal when the taper is likely to start.

"We believe the taper to be formally announced in November for a start date in December, which would be enough to support the USD. If things move more quickly, so too will the USD," HSBC added.

TD Securities strategists believe that at the Jackson Hole symposium, the Fed Chair will repeat the message from the minutes of the July FOMC meeting, namely that a reduction in quantitative easing is likely to occur by the end of this year if the US employment market shows strong data.

However, according to TD Securities experts, we should not expect an announcement right after the Fed September meeting. They continue to forecast a formal announcement of QE cuts in December, although November remains a possibility if the next two US employment market reports will be unexpectedly strong.

Bank of America analysts expect November to be a start date for the Federal Reserve to make cutbacks to its large-scale asset purchases for $120 billion a month. They launched it in December 2020. Earlier, they forecasted the tapering to start in January.

While the stock and currency market reacted turbulently to the latest developments, US Treasury bond and Fed interest rate futures, which track monetary policy expectations, did not change much.

"The market may be using Kaplan's comments as an excuse to take profit on the dollar," analysts at OCBC Bank in Singapore said.

"There has been no clear change in the Fed's expectations. We prefer to focus on more sustainable drivers – macroeconomic concerns and monetary policy divergences – both of which are favorable to the dollar," they stated.

Increased risk appetite provided some support for the EUR/USD pair, but the status of the funding currency may not provide the euro with the recovery it has seen in the past, strategists at ING said.

The experts also added that unless the ECB acknowledges that inflation is becoming more resilient, they doubt that the euro can gain significant independent support from the domestic economy.

The EUR/USD pair rebounded nearly 90 pips from a nine-month bottom. However, this bounce still looks like a correction, not a reversal, as it was mainly due to dollar weakness, while the euro still lacks its reasons for rising.

"EURUSD dropped below the key 1.1700 area last week but bobbed back above in early trading this week. Too early to call this a reversal, as a firmer rally back toward 1.1800 that sticks post- Fed Chair Powell's speech on Friday is needed to suggest we have put in the lows (more about the highs in the US dollar). Until then, the 1.1600 and 1.1500 levels are potential targets to the downside, with 1.1290 the ultimate area as discussed last week. Otherwise, the euro may not prove independently reactive to nearly anything until we get to the other side of the German election," specialists at Saxo Bank said.

The dollar may fall in the short term if Fed Chairman Jerome Powell is more cautious in his speech at the Jackson Hole symposium on Friday compared to his last speech at the press conference following the July meeting of the Central Bank. This will give the market the impression that the process of monetary policy normalization in the U.S. may take longer than previously expected, analysts at Commerzbank said.

The experts also noted that the EUR/USD could fall quickly below 1.1700 again if nothing like that happens.

Meanwhile, the EUR/USD pair is trying to do its best using the increased risk appetite.

Initial resistance is located at 1.1780 and further at 1.1805 and 1.1830.

Support is at 1.1705, 1.1690, and 1.1660.

Above 1.1800 the bearish pressure should weaken, and the pair may aim at 1.1900. However, it is unlikely to happen shortly.

The short-term outlook for EUR/USD is expected to remain negative as long as it trades below the MA 200, which is now near 1.2003.