US Dollar Fundamental Outlook: Fed to Amp Up the Hawkish Mode; USD Should Stay Supported

The dollar was generally stronger in the past week, though the Fx market was in broader consolidation and the modest USD appreciation was nothing but a part of this consolidation. However, the prospects for the dollar to extend the uptrend look good, and the last few weeks could be viewed as the consolidation before trend continuation.

The CPI Inflation reports on Friday were in line with consensus forecasts of 6.8% y/y for the headline and 4.9% for the core CPI. While fortunately, it wasn’t as hot as some feared (7% or higher), 6.8% is still a substantial spike above the 2% official target. This should keep the Fed on track to speed up the pace of QE tapering when they meet this Wednesday. The faster winding down of QE stimulus means the Fed’s shift to hawkish mode is not only fully in force but is also amping up by the day. This clearly sets the Fed apart as one of the more hawkish central banks and continues to be the main factor that should support the USD in the period ahead.

Possibly the FOMC could surprise hawkishly in the dot plot projections, the statement, or the press conference by giving more information about the specific timing when rate hikes may come (e.g., an indication for a March or May hike would be a big hawkish surprise). In this scenario, the DXY dollar index could break the highs around 97.00, with EURUSD moving toward the 1.12 lows.

On the other hand, Powell could deliver a slight disappointment for USD bulls if he emphasizes a more patient approach on inflation or the dot plot projections are not as high as expected. Under this scenario, the USD consolidation may extend for a while longer, though the uptrend would still remain intact.

On the calendar, retail sales are also due on Wednesday six hours before the Fed. On Thursday, traders will also watch the Philly Fed manufacturing index and Markit’s manufacturing and services PMIs. But all of those reports will be subordinated to the Fed and other central bank meetings throughout the week, which should dominate the price action in Fx.

Euro Fundamental Outlook: ECB to Reaffirm Uber-Dovish Position Relative to Other CBs

The ECB meeting is in central focus for the EUR currency this week. They should stay in the dovish camp and reaffirm that rate hikes in 2022 are definitely not on the table. The ECB’s dovish stance remains in stark contrast with the Fed and other central banks who are already pondering rate hikes.

But all that is not without backing from the economic reality. After all, Eurozone core CPI inflation is at only 2.6%, WAY lower than the 4.9% core CPI in the US. Moreover, Eurozone inflation is expected to turn markedly lower starting from next month (January 2022) due to the fading out of various base effects. Therefore, unlike the Fed, the ECB is under no pressure to tighten monetary policy. This is the main bearish factor that should keep the euro in a downtrend over the coming months in Fx pairs such as EURUSD, EURCAD, and EURNZD.

Thursday is a very busy day on the EUR Fx calendar. A few hours before the ECB, flash PMI data (preliminary reports) will be released. The PMIs will show the impact of the latest Covid lockdowns imposed across Europe this autumn. Negative surprises here, potentially coupled with an unambiguously dovish ECB, would be the most bearish EUR scenario on Thursday. In this case, the euro may be pushed to fresh yearly lows, and EURUSD could break the November 24 low around 1.1185. On Friday, traders will take note of the German ifo business climate report.