EUR/USD: Get Long For 1.2155

 | Dec 14, 2017 03:46AM ET


EUR/USD: Fed raised interest rates, but kept policy outlook unchanged
Macroeconomic overview:

  • The Federal Reserve raised interest rates by a quarter of a percentage point on Wednesday, as anticipated, but left its rate outlook for the coming years unchanged even as policymakers projected a short-term acceleration in U.S. economic growth.
  • Having raised its benchmark overnight lending rate three times this year, the Fed projected three more hikes in each of 2018 and 2019 before a long-run level of 2.8% is reached. That is unchanged from the last round of forecasts in September.
  • Fed Chair Janet Yellen, in her last press conference before her four-year term ends early next year, pointed to the Trump administration's proposed tax overhaul as the impetus for an upgrade of policymakers' economic growth forecasts.
  • The Fed now sees gross domestic product growing 2.5% in 2018, up from the 2.1% forecast in September. The pace of growth is expected to cool to 2.1% in 2019, slightly higher than the prior forecast of 2.0%.
  • But Yellen said the precise impact of the tax plan, which includes a sharp reduction in corporate income taxes, depended on various factors. "While changes in tax policy will likely provide some lift to economic activity in coming years, the magnitude and timing of the macroeconomic effects of any tax package remain uncertain," she said.
  • The Fed also said on Wednesday it expected the unemployment rate would fall to 3.9% next year and remain at that level in 2019. It previously had forecast a jobless rate of 4.1% for those two years.
  • But inflation is projected to remain shy of the central bank's 2% goal for another year, with weakness on that front still enough of a concern that policymakers saw no reason to accelerate the expected pace of rate increases. That means that the tax cuts, if passed by Congress, would take effect without the Fed having flagged any likely response in the form of higher rates or concerns of a jump in inflation.
  • Policymakers do see the federal funds rate rising to 3.1% in 2020, slightly above the 2.8% "neutral" rate they expect to maintain in the long run. That indicates possible concerns about a rise in inflation pressures over time. As it stands, inflation is expected to remain below the Fed's target in the near term and is being monitored "closely" by policymakers. Yellen reiterated that the inflation outlook was still considerably uncertain.
  • Chicago Fed President Charles Evans and Minneapolis Fed President Neel Kashkari dissented in the policy statement on Wednesday.
  • The Labor Department said CPI increased 0.4% last month after edging up 0.1% in October. That raised the year-on-year increase in the CPI back to 2.2% from 2.0% in October. Last month's increase in the CPI was in line with market expectations. Excluding the volatile food and energy components, consumer prices ticked up 0.1% as prices for airline fares and household furnishing fell. The so-called core CPI advanced 0.2% in October. As a result, the annual increase in the core CPI slowed to 1.7% in November from 1.8% in October.
  • The greenback had weakened after core consumer price data showed slowing inflation, raising concerns the Fed will be less able to execute multiple rate increases next year.
  • The ECB decision is scheduled for today. The ECB monetary policy is on autopilot, following the October decision to extend QE until at least September 2018 at a reduced monthly pace of EUR 30 billion. Therefore, today’s Governing Council meeting is likely to be relatively uneventful.
  • In our view, investors should focus on two things: 1. the ECB’s new macroeconomic projections; and 2. Possible remarks by Mario Draghi on the range of views within the Governing Council about the termination date of QE.
  • The new macroeconomic projections are likely to see stronger GDP growth and an oil-driven upward revision to the short-term inflation path. Contrary to the September round of forecasts, this time the exchange rate is not going to be an issue, given that at the cut-off date of mid-November the trade-weighted euro was 1% weaker than in the previous set of assumptions. Accelerating global growth and trade, as well as surging sentiment indicators at home are likely to convince the ECB to raise its growth trajectory. We expect the new forecasts to show 2.3% expansion this year (previous: 2.2%), 2.3% in 2018 (1.8%), 1.8-1.9% in 2019 (1.7%) and 1.6-1.7% in 2020. On the inflation front, two things stand out: the strong increase in oil prices relative to the September exercise, and renewed weakness in core inflation, which has erased all the improvement recorded during the summer. Oil prices have jumped, mainly in the wake of tensions in the Middle East, with the front-end of the oil future curve up by about 20% from September assumptions, while the longer-dated contracts are about 10% higher. This is likely to lead to a hump-shaped trajectory for energy inflation.
  • With regard to core inflation, the downward adjustment to 0.9% after the acceleration in the summer to 1.2% is unlikely to flag a trend reversal. Rather, it probably reflects stronger seasonality in holiday-sensitive price items compared to last year. We think that the "real" level of core inflation lies in the middle of the 0.9-1.2% range, which implies some downside risk to the ECB’s forecasts for core prices – currently at 1.3% in 2018 and 1.5% in 2019 – despite a faster narrowing of the output gap. Overall, we expect the ECB to raise its 2018 forecast for headline inflation to 1.5-1.6% from 1.2%, with the number for 2019 likely to be confirmed at 1.5% and for 2020 seen at 1.6-1.7%. These projections would continue to vindicate prudence, patience and persistence in monetary stimulus.
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Technical analysis and trading signals:

  • The EUR/USD pair made a clean break above the 7- and 14-day exponential moving averages. It also pierced the daily cloud top. Daily RSIs bull bias increases.
  • Our target is 1.2155 and we will lift the stop when it is appropriate.