Welcome to the last fully-liquid and event-laden trading week of the year 2021. Before the liquidity drain towards the end of the year, this week is overloaded with major event risk such as the FOMC rate decision on Wednesday and the rate decisions of the Bank of England and European Central Bank on Thursday. Traders are thus prepared for surprise volatility this week.
Top event risk will be Wednesday’s FOMC decision and while the tone-setting Federal Reserve carries far more weight than other central banks, the Fed will avoid triggering surprise volatility. There will be no change in interest rates but catalysts for potential market moves will be the pace of tapering and the timeline for rate hikes. FOMC officials have recently signaled a hawkish shift in their policy stance amidst elevated inflation (CPI hit a nearly four-decade high last Friday), robust economic growth and strengthening labor market conditions. Market participants have thus pushed rate hike speculation up to two full Fed hikes in 2022. Even if Fed officials have turned slightly more hawkish, the Fed perhaps cannot live up to the market’s more hawkish expectations. Traders should thus be prepared for disappointment and a potential U.S. dollar retreat.
Bank of England rate hike unlikely
The risks remain tilted to the downside for the British pound while the market still sees a 42 percent chance of a 15bps rate hike Thursday. However, the BoE is not expected to raise rates this time due to the newly uncertain economic outlook. Moreover, the BoE is much more likely to raise rates in months when it also delivers forecasts and a press conference where it can explain the decision to the public. The next one of those will be in February. Nonetheless we bear in mind that policy makers have warned that the consequences might be steeper when rates are raised later. In other words, BoE policy makers may have to raise rates further than markets currently expect to moderate inflationary pressures.
GBP/USD Technical view: Chances of a reversal
Given the oversold situation of the pound in longer time frames, we may get close to peak bearishness with increasing chances of a reversal toward 1.35. As long as the cable holds above 1.3150 and 1.31, bulls may regain some control in this pair.
Euro traders are well advised to sit on the sidelines until Thursday
The European Central bank meeting on Thursday is difficult to predict as there could be an internal battle between hawks and doves. The dovish core of the council will want to avoid premature tightening while high inflation and near-term upside risks could justify the removal of the ECB’s policy support. However, as long as an interest rate hike is not in the cards, the euro may trend to the downside against other peers.
EUR/USD Technical view: Waiting for a bear flag confirmation
In longer time frames the euro formatted a potential bear flag (green trend channel lines) within the recent downtrend. Should the pair now show a weekly close below 1.1250, we could have a confirmation of the bear flag with the focus shifting to lower targets at 1.11 and 1.10. For a bullish breakout on the other side, we would need to see a significant break above 1.1450. As long as the euro remains trading between 1.1450 and 1.1250, we will maintain a wait-and-see attitude.
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