The US Dollar extended its corrective rally on Monday but the prospects for a reversal are still limited. There are number of events this week which merit our attention and whose outcome can tap the brakes on the weakening of the US currency. Among them is a confirmation hearing of Janet Yellen as the new chief of the US Treasury, policy meetings of the ECB and Bank of Japan as well as the EU summit. Impeachment of Trump, civil unrest in the United States (with still unclear spin-offs), the risks of EU fragmentation due to a re-emerging political crisis in Italy which has temporarily sidelined the global reflation theme and associated bets on continuation of the bull market.
Nevertheless, better-than-expected data on the Chinese economy effectively prevented the escalation of market apprehension into full-blown anxiety. GDP growth in the fourth quarter accelerated to 6.5% with a forecast of 6.1%, industrial production increased more than expected but retail sales missed estimates. Interestingly, the pattern of weak retail sales and steady growth in industrial production were noticed in statistical data from other large economies, which indicates that recovery is sustained (due to resilience in production) and is synchronous.
Consolidation of the US Dollar, slower than expected vaccination rollout in the EU and the vote of confidence in the Italian parliament thwarted the bullish momentum in EURUSD. Over the next two days, there will be a lot of news in Italy that will show in which direction the Italian crisis is heading. Among possible market implications so far, we can conject more aggressive bond purchases by the ECB to smooth out the flight of investors, but this would be enough to help EURUSD bears to push the pair towards 1.1950/1.2000. In my opinion this area will present a potential reversal zone on EURUSD where resumption of the upside trend should be considered.
Regarding the ECB meeting which is due on Thursday, all eyes and ears will be on Lagarde's remarks about euro exchange rate. Over the past year, European currency has strengthened significantly and is now near an all-time high:
Strong national currency negatively affects revenue of EU exporters, which the ECB cannot ignore. At the last meeting, Lagarde limited herself to commenting that the ECB is closely monitoring exchange rate. However, even in the case of verbal intervention, the effect on the euro will not last long. No change in ECB policy is expected as despite low in December and some short-term risks for consumer spending due to extended lockdowns, the outlook for inflation for 2021 looks benign thanks to initial momentum after lockdowns are lifted.