EURUSD – key events to consider

By David Morrison  |  06/12/2017 17:07

On the first trading day of this year, the EURUSD traded below 1.0350 to hit a 14-year low. The move led a number of commentators to forecast that the pair was on course to trade at parity for the first time since the end of 2002. However, the single currency subsequently put in a solid rally. The euro pushed higher until mid-September when the EURUSD broke above 1.2000 to hit its highest level since early 2015. The dollar then recovered a touch in a move which saw the pair retest support around 1.1600. Then the euro bounced, briefly hitting the 76.4% Fibonacci Retracement of the September-November pull-back around 1.1960. Now the dollar has undergone a mild recovery and the big question is where we go from here. My colleague Ashraf Laidi will be looking at the technical set-up behind some currency pairs in tonight’s webinar and a seminar tomorrow evening. You can get a taster of his thoughts here.  We’ll consider some of the fundamental influences on the EURUSD in this commentary.

The dollar got a boost this week on the increased likelihood of an agreement on US tax reform being reached before the year-end. Last weekend investors were taken by surprise after the Republican proposals for tax cuts passed through the Senate. On Monday the Republican-controlled House of Representatives voted to go to conference with the Senate to begin formal negotiations.

Tax reform is seen as positive for the dollar. The thinking behind this is partly that the proposed corporation tax cut will help US multinationals to reduce prices, be more competitive overseas and thus boost sales. Also, multinationals will want to take advantage of a tax break on repatriated overseas earnings and convert foreign currency into dollars to send it home. But there’s still a high probability that the tax reform package gets messed up under a barrage of compromises. After all, there are a number of significant differences between the reforms voted on by the House and those passed by the Senate, both in scope and timing. Even if Congress reaches agreement, there could be some negative kick-back if the market decides that unfunded tax cuts (which could cost anything between $3 and $7 trillion over the next 10 years, according to the Committee for a Responsible Federal Budget) are too much of a burden on top of record levels of national debt.

Meanwhile, the Federal Reserve holds a key monetary policy meeting next week. According to the CME’s FedWatch Tool there is a 90% probability that the Fed’s FOMC (Federal Open Market Committee) will vote to raise rates by 25 basis points. While this has fallen back from the 98% level hit a few weeks ago, it still means that another rate hike next week is effectively nailed on – at least as far as players in the fed funds futures market (which is what the FedWatch Tool is based on) are concerned. It’s fair to say then that a failure of the FOMC to raise rates next Wednesday would be a shock.

But the December meeting also sees an update to the FOMC’s Summary of Economic Projections. The summary includes the committee’s forecasts for US unemployment, GDP growth, inflation and the Fed funds rate, expressed in the “dot plot”. Back in September the FOMC’s “dot plot” indicated that members anticipate a further three rate rises throughout 2018. This is despite Core PCE (the Fed’s preferred inflation measure) coming in at 1.4% in October when compared to the same period twelve months’ ago. While this was a slight pick-up from the 1.3% reported in August it remains a long way short of the Fed’s 2% inflation target which is a worry for the central bank. Wage growth is tepid despite the US Unemployment Rate hitting its lowest level in 17 years in October. On Friday we get a fresh update on the US employment situation on Friday with the release of Non-Farm Payrolls (more on this in tomorrow’s update).

It will be important to look out for any changes to the “dot plot” together with any change in tone from the FOMC. If committee members row back on their anticipated rate of tightening from September’s meeting, then we can expect this year’s dollar decline to continue.

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