FX.co ★ EUR/USD: the main thing for the euro now is to hold out until Monday, if, of course, Powell does not cause hysteria in the markets. Dollar is already making plans for the fall, believing that the Fed will announce a cut in QE late or early

After a little hesitation, the main Wall Street indexes continued to grow and updated their record peaks on Wednesday.

Bulls can say that the highs in the market are justified by strong corporate reporting and an increase in dividend payments.

According to Bank of America, over the past 196 trading sessions, the correction for the S&P 500 index has never reached 5%.

Traders are increasingly wondering what will be the next catalyst that can push the market to growth, analysts at BMO Wealth Management say.

"It is possible that the current set of risks will be enough to force investors to take a pause," they noted.

Among the potential threats, analysts highlight inflated valuations of most asset classes and the weakening of monetary incentives from the Federal Reserve.

Last Tuesday morning, S&P 500 futures began to sharply decline and by Thursday afternoon they had lost almost 3%, which by today's standards can be considered a real collapse. However, then the market quickly recouped all the losses, since investors apparently had a buy reflex developed over the past year on any drawdowns.

After reaching a pandemic low in March 2020, the S&P 500 index has grown by more than 90%.

Bank of America believes that the sell-off in the US stock market that took place last week is a sign that investor sentiment remains nervous and may be vulnerable to more serious shocks in the future.

"The stock market is enjoying record monetary support from the Fed and still sees distant prospects for tightening monetary policy in the United States due to the extreme uncertainty in the regulator's macro forecasts, which it justifies its decisions. However, we believe that the market underestimates such risks," the bank's strategists said.

In their opinion, Fed Chairman Jerome Powell's speech at a virtual conference in Jackson Hole on Friday may provoke stock market volatility. Analysts also called the US employment data for August, which will be published on September 3, and the Fed meeting scheduled for September 21-22, as potential catalysts.

Last month, the head of the US central bank came close to unveiling plans to reduce QE, going so far as to call the July FOMC meeting a "meeting for talking".

The subsequent signals from Fed officials that they considered the curtailment of asset purchases this year as the most likely caused a sell-off in the US stock market and helped the USD index rise to a 9.5-month peak around 93.73 points.

However, then the US stock indexes were able to recover, returning to an upward trajectory, while the greenback went down, as there was a sharp change of sentiment before Jackson Hole.

A series of disappointing macroeconomic reports on the United States, as well as a surge of COVID-19 disease in the country, gave rise to expectations that the Fed will not rush to curtail monetary stimulus, which only strengthened the comments of Dallas Fed President Robert Kaplan.

Last Friday, he said that he could change his mind about an early reduction in support for the national economy if the coronavirus significantly slows down economic growth in the United States.

Analysts at Mizuho Bank believe that the Fed will take a more cautious approach to tightening monetary policy against the background of weaker recent statistical data on the United States.

"The latest US data is generally disappointing, and this is partly why we think that the Fed will not rush, although it should have already reached the peak of rigidity in its rhetoric," they said.

The wave of optimism that covered the markets this week put pressure on the protective dollar. As a result, the greenback retreated from multi-month highs by more than 0.9%. However, in recent days, the pace of its decline has slowed down somewhat.

The greenback is still staying near weekly lows, having found support in the area of 92.80–93.00.

The dollar continues to stay afloat on the grounds that sooner or later the Fed will start tightening policy. The question is only about the time of the announcement and the start date of the reduction of asset purchases by the central bank.

Some experts assume that the central bank will signal the curtailment of quantitative easing at the next meeting, which will be held on September 21-22.

"Now, when the next nine months of quantitative easing are embedded in a huge volume of reverse REPO operations ($1.1 trillion), the US central bank would already be rapidly reducing monetary stimulus if it were not for the delta covid. The Fed may announce plans to reduce QE at the September meeting, " Saxo Bank specialists noted.

Given the continuing uncertainty associated with the spread of COVID-19 in the US, it is likely that the Fed will prefer to see one or two more stellar employment reports before announcing a reduction in asset purchases, National Australia Bank believes.

Economists at Goldman Sachs have increased the probability that the Fed's official announcement of a reduction in QE will occur in November to 45%, compared with the previous forecast of 25%.

"The November announcement, combined with the pace of $15 billion per meeting, would mean that the FOMC will make a final cut at its meeting in September 2022," they said.

Even if the Fed refrains from hinting at a reduction in quantitative easing for the time being, fears related to the spread of the delta variant of the coronavirus in the world will support the dollar, Rabobank believes.

"As winter approaches, policymakers in various countries fear that some strengthening of restrictions related to COVID-19 may still be necessary, despite rising vaccination rates," the bank's strategists said.

"The Fed's hawk, Robert Kaplan, indicated last week that an increase in the number of cases of a more contagious variant of the coronavirus in the United States may force him to reconsider the timing of his support for reducing quantitative easing. On the one hand, this will be a negative factor for the USD, on the other hand, concern about the situation around Delta may increase the attractiveness of the greenback as a safe haven asset," they added.

They predict that the euro exchange rate against the US currency will sink to $1.16 on a six-month horizon.

EUR/USD has risen markedly over the past four days amid a broad front pullback of the dollar and weakening expectations that Powell will point to a tapering chart when he speaks at the annual Jackson Hole symposium.

Many investors do not expect surprises from Powell, believing that he has little reason to rock the boat.

However, the comments of Powell's views on the prospects for monetary policy in the United States may significantly affect the USD exchange rate and stock indices if he makes unexpected statements.

In addition, Powell's comments will depend on whether the EUR/USD pair can reach the peak levels of mid-August above 1.1800 or fall below 1.1700 again.

If Powell will confirm the recent signals of the Fed leaders that a statement on curtailing stimulus may be made at the next central bank meetings, this may lead to a decrease in the propensity of investors to buy risky assets, and the dollar will receive support. Otherwise, the greenback risks continuing to decline.

"The Fed has been talking about a reduction for quite some time, and therefore, if you don't expect it, you may be caught off guard," said Natixis Investment Managers Solutions.

"The markets expect that Powell will sound dovish and echo the concerns of Robert Kaplan, the head of the Federal Reserve Bank of Dallas, who last week said that he might reconsider the timing of the start of quantitative easing reduction due to the COVID-19 delta variant," Scotiabank strategists noted.

"However, the risk is that Powell will not really say anything special, but due to the fact that he does not support Kaplan, the tone of his statements will be more hawkish," they added.

Although Powell may want to leave the door open for the start of the reduction in November, he will be very careful with fixing such deadlines, economists at Goldman Sachs believe.

"It is difficult to imagine that the Fed has committed to a specific indication of the timing of the reduction in the light of the ongoing public health crisis," Jefferies analysts said about the upcoming speech by Powell.

Since the last FOMC meeting, the situation with COVID-19 in the United States has noticeably worsened.

Although the number of daily coronavirus infections in the country exceeded the 150,000 mark, which is ten times more than in June, the indicator of 14-day changes has slowed down in recent days, falling to 28% from a three-digit level. Moreover, the rate of vaccination in the United States has started to grow again.

If the epidemic slows down, the Fed will be able to start reducing the bond purchase scheme by $120 billion per month. Printing fewer dollars will have a positive impact on the US currency.

Even if Powell's speech does not bring any news of exactly when the Fed will begin phasing out stimulus, it is clear that the central bank is on the way to tapering.

When the US central bank finally announces a reduction in QE, a reverse report will be launched to raise interest rates.

At the moment, the derivatives market estimates at 35.6% the likelihood that the federal funds rate will remain unchanged following the Fed meeting on December 14, 2022. It is noteworthy that a month ago the figure was 44.5%.

That is, almost a month has passed since the last FOMC meeting, and the market has priced in the faster tightening of the Fed's monetary policy. In other words, there is a greater likelihood of QE curtailing and raising the interest rate.

While some leading central banks have already indicated a tendency to start tightening monetary policy, the European Central Bank is likely to be the last to take steps in this direction.

Yesterday, the ECB's chief economist Philip Lane said that it was too early to discuss the completion of the PEPP asset purchase program.

According to him, the ECB intends to maintain favorable financing conditions in the eurozone at least until March next year.

The fact that the ECB will keep interest rates low for a longer period than its US counterpart is unlikely to add to the optimism of the single currency.

The EUR/USD pair was able to recover after updating the annual low, but its further path seems bumpy, since Europe still has its unresolved problems.

According to the latest data, representatives of the business community of the region are seriously concerned about the fourth wave of COVID-19, despite the high vaccination rates in the eurozone.

In addition, the political situation in Germany is becoming uncertain.

"There is a month left before the parliamentary elections in Germany, and a new chancellor will be guaranteed, given that German Chancellor Angela Merkel is resigning. Although this may not affect the foreign exchange market during the elections themselves and in the run-up to them, who will lead Germany is still crucial. Recent polls also indicate greater uncertainty about who will win," MUFG analysts noted.

"The main risk that the elections will have an impact on the euro will come from a very separate election result, which will increase concern about a period of political instability or a coalition and a leader who does not have enough powers. In this sense, in the coming weeks, we should closely monitor the polls of voters in Germany," they added.

As for the technical picture, the EUR/USD pair still maintains a positive momentum. It has risen above the 100-day moving average, but continues to trade below the 200-day moving average. This indicates that, in general, the bulls are leading, but they have not gained full control over the situation.

"The EUR/USD pair is intensively breaking through to the short-term downward trend line at 1.1772, the breakthrough of which can confirm the formation of a descending wedge reversal pattern. As long as it holds, we cannot rule out the possibility of retesting the recent low at 1.1665, " Commerzbank strategists said.

"Below 1.1665, 1.1602 (November 2020 low) and 1.1575 (200-week moving average) will come into play. If the downward trend closes above the 1.1772 line, the bulls may target 1.1909 (the July high), and then - to the area of 1.1990–1.2006," they believe.