At the end of last week, the euro / dollar exchange rate fell to the support level of 1.1725. The latest US macroeconomic data showed a slight slowdown in the growth rate of inflation in August, but it continues to remain at an elevated level by historical standards.
Traders expect that the US regulator will sooner or later be forced to start reducing the asset purchase program. The specific plans of the regulator may become clear as early as next Wednesday, and until that time, market participants will probably prefer not to open large positions. In the Eurozone, consumer inflation rose by 1.6% in August, and this fully coincided with the preliminary estimate. ECB Governing Council member Olli Rehn said that economic growth in the Eurozone remains strong, but still requires support from the regulator. There is no question of raising rates yet. Inflation in the euro area has strengthened recently, but the temporary effects are expected to disappear in 2022. Price growth is likely to decline again to levels below 2% in the medium term.
According to the ECB representatives, with the right monetary and fiscal policy, a fairly strong recovery due to demand should lead to a return of inflation to 2% in the medium term. According to Wells Fargo analysts, in the next six months, the dollar exchange rate is likely to grow by 5% rather than decrease by a similar amount. A hawkish surprise from the Fed is much more likely than a similar surprise from the European Central Bank. This means that an increase in the rate differential between the US and Europe, and with it a strengthening of the US dollar, is more likely than a decline in the coming months. This view is based on the assumption that monetary policy and short-term rate differences are the most important factors of the currency markets at present.
A 5% or more decline in the dollar is likely to require either a soft surprise from the Fed or a hawkish surprise from the ECB. Wells Fargo sees an extremely small risk that the European regulator will adopt a strategy that will significantly change the expectations of a rate change over the next six months. The Fed may refuse to tighten monetary policy if the data on inflation or employment in the US are significantly worse than expected. However, short-term rates in the US are already almost zero, which means that there is probably more room for an increase than for a decrease. This point of view may be incorrect if the foreign exchange market focuses on any other driver besides monetary policy. But even in this case, Wells Fargo doubts that any of the other factors will be able to tilt the balance of risks towards a significant fall in the dollar, rather than growth.
The forecast assumes a further decline in the euro/dollar exchange rate to the levels of 1.1700, 1.1680 and 1.1660.