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US dollar surges upwards after Fed meeting minutes

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The US dollar surged upwards following the recently published minutes of the Fed meeting in December. While the hawkish position of the meeting was long expected, the report pushed USD up.

Most FOMC members expect at least 3 interest rate increases of 0.25% this year. In September 2021, board members did not even consider hiking the rate until 2023.

Rising inflation is the main reason for the Federal Reserve's decision. For several months, soaring prices were regarded by Fed economists as transitory. They stated that inflationary pressure was caused by supply chain issues and would ease by itself. Jerome Powell quickly adjusted the regulator's policy afterwards and set a more hawkish course. The current conditions in the US economy and the labor market allows the Fed to tighten its policy.

Wednesday's ADP payroll report beat market estimates. Although it does not strongly correlate with the non-farm payrolls, investors expect the number of new jobs to rise significantly. Economists expect that the US economy gained about 400,000 new jobs in December, which should push the US dollar even higher.

Market players are concerned about the timeline for the end of monetary stimulus and the following interest rate hike. The Federal Reserve could only decide upon its further actions at its next meeting on January 25-26 at the earliest.

The wind-down of QE, which was originally expected to end in June, has now been accelerated. If asset purchases are fully concluded in March, the Fed could discuss raising interest rates from near zero in mid-March.

"Participants generally noted that, given their individual outlooks for the economy, the labor market, and inflation, it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated. Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve's balance sheet relatively soon after beginning to raise the federal funds rate", the Fed report said.

Expectations for a hike in March have increased to about 70%, according to the CME FedWatch Tool.

USDX pared some of the gains it had made at the first session of the year. However, demand for the US dollar increased following the release of the Fed meeting minutes. The yield of 10-year US treasury bonds reached a 2-year high of 1.7%. The nearest resistance for the index lies at 96.46 (the weekly high starting from January 4). A break above 96.46 would allow the pair to move up towards the high of November 2021 at 96.93, with 97.00 being the first target for bullish traders.

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Although the euro managed to rise somewhat during USD's temporary retreat, EUR/USD is unlikely to go up significantly. The pair could likely only reach the 1.1300 area. Even if the US dollar weakens due to falling bond yields, EUR/USD's upside potential would remain limited.

The pair would encounter resistance at 1.1320, 1.1340 and 1.1360. Its support levels are 1.1270, 1.1240 and 1.1200.

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EUR/USD could break below the lower boundary of its 1.1180-1.1380 range in early 2022, analysts say. The pair has remained in that range since the end of November 2021.

"Our preference is still for the range to be broken to the downside, but this may have to wait until US data is strong enough to convince investors of three Fed rate hikes this year (our house view) and a bigger multi-year tightening cycle. We favor the break lower coming in the early part of the year since through 2H22 the market will start to shift its focus to the first ECB hike, probably coming in March 2023", an outlook by ING commented.

The euro could rally in the second half of 2022, once the markets begin to focus on the ECB increasing the interest rate next year.

The material has been provided by InstaForex Company - www.instaforex.com

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