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In this midyear Fx outlook, we are going to revisit some of the monthly charts that we analyzed in January this year as part of our 2021 yearly outlook. You can see that analysis here and, if you like, compare the forecasts with what has happened in the market since then (our predictions are not far from reality).
We’ll also have a look at the outlook for gold - an asset which many investors consider much more relevant in the current “inflation-scare” environment than any analysis of fiat currencies. With central banks injecting so much stimulus into the economy, the biggest debate among traders and investors is whether fiat currencies will keep losing value with inflation eventually spiraling out of control. So, we’ll discuss the outlook for gold as it relates to the Fed’s tapering plans as well as the most important technical S/R zones on gold’s long-term charts.
The main drivers currently driving the markets are centered around the Fed and the US dollar, so the focus of our analysis is on the USD fundamentals.
Note: We’ll be taking two weeks off starting from next Monday (August 23), and our weekly analysis and the trade signal newsletters will be on pause for that time. We will return with the weekly analysis and trade recommendations from September 6. In the meantime, stay tuned for our long-term Forex outlook that will be published later this week.
US Dollar Fundamentals: Fed tapering likely to keep USD strong in months ahead
The Fed’s hawkish meeting on June 16 marked a significant turning point in the Forex and precious metals markets that seem to have set the stage for the whole second half of 2021. The dollar confirmed the bottom, and now (August 20, 2021), it’s trading at a 9-month high with more gains likely to come.
This dollar rally appears to be the start of a new bullish leg. The higher than expected inflation readings in the US during the spring have tipped the Fed over to the hawkish side. Powell and other FOMC members are now actively discussing tapering QE (not only thinking about thinking), and some within the Fed are worried about the higher inflation getting out of control (already running above 5%).
While it is likely that inflation will cool off over the coming months, the hawkish Fed was all the market needed to revive the dollar, which remained crushed pretty much since the start of the Covid crisis in March/April 2020. The prospects of tighter monetary policy in the US and eventually higher interest rates are shiny compared to the ECB and other major central banks that remain far from reaching the point of tightening policy in any way. This divergence between the Fed and others can once again be the crucial factor that will support the dollar higher.
That being said, let’s look at the pivotal events that are in focus for the next few weeks:
· the Jackson Hole symposium next week (August 26-28)
· the Nonfarm payrolls report on September 3
· the Fed meeting on September 22.
The markets are anticipating a QE tapering announcement from the Fed at either of the two events (Jackson Hole or September 22 meeting). These expectations are bullish for the dollar and are currently the factor that’s driving the USD higher. If the Fed delivers the QE taper (especially next week at Jackson Hole), then the USD will likely soar and break the important technical areas on many USD pairs.
Between Jackson Hole and the September 22 meeting, the Fed and traders will closely watch the Nonfarm payrolls report on September 3. Most Fed officials have said they want to see another strong jobs report before they support a tapering decision. Thus, this NFP report will also be crucial for the USD outlook. Although unlikely, if the NFP fails to live up to expectations or completely disappoints, the Fed could abandon all taper talk and the dollar will get crushed.
The Delta variant vs vaccines
A risk to the above bullish USD outlook can be anything that derails the strong economic recovery in the US as it would most likely also derail the Fed’s tapering plans. The Fed is only willing to talk about tapering because of the solid recovery in jobs and growth. If those slow down or reverse, so will the Fed’s hawkishness. Such a scenario would disappoint USD bulls and will likely send the dollar much lower.
Namely, the main risk that can slow the recovery is the delta variant. Covid cases are rising rapidly again in the US, despite the high vaccination rates, which highlights the reduced effectiveness of the vaccines in preventing infection with the delta variant. The rapid increase in infections is also increasing hospitalizations and deaths - a risk that could eventually hurt the economic recovery, even if the virus is mostly affecting the unvaccinated now. As the Fed has stated many times, the economic recovery will depend on the course of the virus, and this is why the “delta variant vs vaccines” dynamic will be the key one over the next months. Will vaccines eventually prove effective even against new strains for Covid, and will countries suffer under more lockdown restrictions in the future? The sooner Covid is put under control in the US, the sooner the Fed can remove stimulus and unleash a stronger USD rally.
The above dynamics will likely be the main drivers for the dollar over the coming months. So, we need good economic data from the US economy, containment of Covid infections and decrease in hospitalizations and death rates, and a hawkish Fed that proceeds with tapering. Under this scenario (which appears as the most likely from the current perspective), the dollar should strengthen from here.
Euro Fundamentals: ECB’s change of inflation target to keep EUR an underperformer for longer
The key reversal for the euro this year was the ECB’s strategy review (released in July), where they decided to change the inflation goal to asymmetric targeting of 2% rather than inflation below 2% as previously. This change essentially makes the ECB a more dovish central bank, now set to remain one of the most dovish central banks in the world for longer and keep interest rates in the negative for longer.
The German federal election on September 26 is the EU’s most important political event of the year, though it’s unlikely that it will have a huge impact on markets. Other than the fact that the election marks the end of Angela Merkel’s era, there is little chance for a major political change in Germany. It will be important, however, to see parties in support of more EU integration winning the majorities, which would be supportive for the euro. Stronger EU integration is good for the Eurozone and the currency, especially when it comes from Germany. On the other hand, a risk around the election would be if EU-sceptic parties possibly make significant gains in the election, which would be a negative shock for the euro currency.
Overall, the likely direction for the EUR remains lower for the coming few months, as long as the Eurozone economy remains a laggard behind the US and the other developed countries. The expectations for the German election are to have a muted impact on the EUR, as noted above, though as usual, the election will be closely watched by traders and investors.
EURUSD Technicals: Visiting the 1.15 area is becoming a highly probable scenario
In January, we said the 1.25 resistance in EURUSD was a significant barrier that won’t break easily. It turns out, EURUSD didn’t even reach it and slid lower from the January 6 high around 1.2350. The important support zone at 1.20 then gave way, and the break was reconfirmed with the drop on June 16. EURUSD is now making new lows for the year.
The chart below reveals that monthly support exists at 1.16, then the more important one at 1.15 (highs of March 2020). The next key support lower is the 1.13 – 1.12 area, which is the broken trendline of the 12 year channel. It is also the potential target area of the head and shoulders pattern that is now in play on EURUSD on the weekly chart (which we discussed in more detail here).
Resistance zones to the upside remain at 1.20 and the 1.2350 January highs. Of the two resistance zones, 1.20 seems to have become a little less significant on the monthly chart, simply because of the lack of a stronger reaction in the previous 2-3 instances when the market broke it (both up and down this year).
Gold Fundamentals: Hawkish Fed can hurt gold further
Gold hasn’t been able to extend its rally since August 2020, practically for more than a year now, even as US inflation has surged above 5% y/y. Why is that? Let’s review some reasons below.
- A lot was priced in and widely expected a long time ago, including the massive stimulus and the inflation spike we are currently seeing (this is what drove gold higher from April to August 2020)
- Bitcoin has probably taken some shine off gold. Although it’s highly volatile and far from reaching the established safe-haven status that gold enjoys, many investors view Bitcoin as an alternative to gold. So, Bitcoin was successful in taking some flows away from gold and, therefore, has probably undercut the gold rally to an extent.
- Most investors and economists still view the risks of inflation spiraling out of control as low. In the meantime, the Fed has responded to the higher inflation by turning more hawkish and has additionally hit gold since that June 16 meeting.
What’s next for gold?
The drivers we discussed above in the USD outlook section will also largely hold true for gold as the main drivers. Thus, a stronger dollar would mean weaker gold prices and vice versa. In this regard, what the Fed does next is crucial for gold traders also.
With the Fed set to announce a QE taper over the next weeks, the risk of a deeper sell-off in gold is growing by the day. In the current environment of the vaccines putting the pandemic slowly under control, the outlook for gold is more bearish than bullish. There is potential for a significant sell-off once some key technical zones are broken. For the details, look below in the “Gold technicals” section.
From the current perspective, it seems only a surprise negative turnaround in the economy could derail Fed’s plans for tapering and, therefore, be a potential factor that can jump-start gold’s rally.
Gold technicals - The importance of 1700 revealed
The technical situation shows great indecisiveness and conflicting views among gold traders. Technically, there are both bullish and bearish arguments of equal weight at the moment. Below we highlight both arguments:
Bearish gold arguments:
· long-term bullish channel (that connects back to the 2018 lows) was broken in recent weeks
· monthly chart shows big bearish engulfing candle (June)
· bullish breakout above the 1830-1850 resistance was a fake (after the rejection in June)
· death cross on daily chart (50-day crossed below 200-day moving average)
Bullish gold arguments:
· Price rebounds from the latest attempt on 1700 support (therefore, keeping the possibility that the bearish break of the channel support might be a fake one)
· 1700 support is now a double bottom
· Predominant trend is still very much bullish
While it may not be clear whether the bulls or the bears have the stronger arguments, one thing is clear for gold traders. That is the importance of 1700 as a support area.
As can be seen from the chart, 1700 is crucial for both the bulls and the bears in the current context. The bulls will capitulate on a bearish break of 1700, while the bears can’t feel confident in more selling as long as 1700 holds. Therefore, this is the crucial technical zone to watch in the coming weeks, especially going into the key Fed events in Jackson Hole and the September 22 meeting.
· In case 1700 gives way, heavy selling is likely. Levels as low as 1450 and then 1350 will become realistic scenarios.
· On the other hand, the bulls need to break above the 1850 area to feel more confident that new all-time highs are on the cards for gold
Trade signals from past weeks (sent via the Free Profitable Forex Newsletter)
- Long USDCHF from 0.9050 (open and in progress to target, currently 120+ pips in profit); trade idea sent on June 18and triggered on August 5
- August 16 - Short EURJPY from 128.90, currently about 60+ pips in profit ; trade idea sent on August 13
TOTAL: 0 pips in the past week
TOTAL: +3845 pips profit since October 1, 2018
