The new variant of COVID-19 could change the Fed’s monetary normalization schedule if the omicron is more dangerous than the previous variants. Let us discuss the Forex outlook and make up a EURUSD trading plan.
Weekly US dollar fundamental forecast
Will central banks step back from their plans to normalize monetary policy because of omicron? Based on the recovery in stock indexes and oil, investors are optimistic. However, the demand for safe-haven assets is still high, the futures market has reduced the chance of three Fed’s rate hikes in 2022, and the risk reversals shift towards the US dollar opponents. On Black Friday, the EURUSD risk reversals featured the best performance since March 2020, so the euro has naturally shown the best rally against the greenback since December 2020.
Of course, the omicron has brought uncertainty not only for humanity but also for financial markets and central banks. Jerome Powell believes the new strain of COVID-19 will make it difficult to fulfill the Fed’s dual mandate. Fears will prevent people from returning to work, which, on the one hand, will reduce economic activity and become a serious obstacle to the recovery of the labor market; on the other hand, it will further fuel inflation by exacerbating the supply deficit and rising wages. At the same time, worsening supply chain problems will spur the CPI and PCE rallies.
Janet Yellen noted that without progress in the fight against viruses, there would be no progress in economic recovery, but investors are increasingly convinced that COVID-19 will not be defeated. The world will have to live with it. We can only hope that thanks to vaccines, humanity and the world economy have adapted to the pandemic. Berenberg Bank notes that the damage to GDP decreases from wave to wave and cites the example of the euro area. Its economy sank 15% in the second quarter of 2020 but lost only 0.7% amid a more dramatic pandemic wave in early 2021.
If economies have to exist with COVID-19 for a long time, perhaps the same goes for high inflation. No matter how much the representatives of central banks talk about its temporary nature. Christine Lagarde and François Villeroy de Galhau echoed the mantra of a short period of high prices after Germany’s CPI soared to 6% in November, the highest in three decades. Isabel Schnabel recalled that inflation in Germany grew by an average of 2% before the pandemic, then slowed sharply in 2020 and skyrocketed in 2021. There is no reason to assume that prices are spiraling out of control.
The euro area inflation is impressive, but it is even higher in the US, forcing the Fed to act aggressively. However, the omicron could make the regulator abandon its plans.
Weekly EURUSD trading plan
I believe there is a situation similar to that a year ago when investors were divided into pessimists and optimists. The former believed that vaccines would not work, and the Fed would have to add monetary stimulus, while the latter were convinced of the opposite. Today is another level. The question is, will the Fed continue to normalize or stop? It depends on the omicron and allows us to both sell the EURUSD on the breakout of the support at 1.126 and buy the pair in case of a breakout of the resistance at 1.133.
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