1Finance

The new year begins with the interest rate differential strongly favoring the U.S. Dollar over the Euro. Simply stated, the U.S. Federal Reserve is getting ready to raise interest rates in 2015 while the European Central Bank is gearing up for a fresh round of quantitative easing (QE). Rates should rise in the U.S. and should fall in Europe, increasing demand for the Greenback.

The key factor that will determine the ECB’s decision on quantitative easing will be inflation. The central bank is trying desperately to prevent deflation from creeping into the economy. Inflationary spikes can be tolerated because the central banks have aggressive tools to fight this. However, deflation is a difficult challenge because central bank weapons are limited.

The ECB will start to get important inflationary data early in the month which should cause a volatile reaction from traders in either direction. The first key date to watch is January 7. On this date, traders will get the opportunity to react to the latest CPI Flash Estimate and Core CPI Flash Estimate. These reports should determine what the ECB will do about QE at its monetary policy meeting on January 22.



Oversold conditions could produce periodic short-covering rallies throughout the month, but these rallies are likely to set up fresh shorting opportunities. The monthly chart indicates that the fundamentals are bearish and even if they did begin to change, it would take several months to clear out the shorts and form a bottom.

The key number to watch early in the month is the July 2012 bottom at 1.2042. This is the first major downside target so traders may try to take care of this price early in the month. If the selling pressure persists then look for the downside momentum to continue down to the June 2010 bottom at 1.1876.

The 1.2042 price level may be treated like a pivot throughout the month. A sustained move above it may even trigger a rally back to 1.2341, but this is unlikely to occur unless the ECB backs away from implementing QE this month.

The initial reaction to QE should be bearish for the Euro. The size of the break will be determined by the size and length of the program. Some optimistic investors feel the EUR/USD will decline during the first quarter of 2015, but will strengthen throughout the year because the QE will start to help stimulate the Euro Zone economy. Others feel that the U.S. faces too much exposure to China and this could derail its economy.

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