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EUR/USD plunges towards parity on Fed rate hike outlook

EUR/USD continued its plunge on Thursday, a day after the US Federal Reserve hiked interest rates by 25 basis points to 0.50%-0.75%, as widely expected. This rate increase is only the second in ten years, and follows a full year after the Fed’s new monetary tightening cycle began in December of 2015.

The Fed’s rate hike this time around was strongly anticipated by the markets and was therefore not likely to trigger heightened volatility and market movement. More critical than the December hike alone was the Fed’s outlook for future rate hikes, given the expected rise in economic growth and inflation under a Trump Administration.

As it turns out, the Fed accompanied its rate hike on Wednesday with a “dot-plot” outlook that indicated higher interest rate expectations than had been previously expected. In the Fed’s September meeting, long before Donald Trump secured his surprise election victory, Fed officials had forecast only two rate hikes in 2017. That forecast has now risen to three, and could rise even higher after the new administration takes office and the Fed reassesses the outlook for Trump-driven inflation and growth. Fed Chair Janet Yellen noted during Wednesday’s press conference that Trump’s economic plans indeed affected the Fed’s rising interest rate outlook.

Therefore, while Wednesday’s rate hike itself was not a substantial catalyst for market movement, the prospect of quicker rises in interest rates going forward led to some very expected market reactions. Most notably, the US dollar rallied sharply while gold continued to plunge.

This dollar rally prompted a sharp fall for EUR/USD back down to key support around the 1.0500 level on Wednesday, before the currency pair followed-through on Thursday by breaking down further. Having shattered this major 1.0500 support barrier and established a new 14-year low below 1.0400 in the process, EUR/USD has reached a critical juncture. Under the 1.0500 level (now resistance), the currency pair’s next major downside target is around the 1.0200 support level. And further to the downside, the likelihood of EUR/USD hitting parity (1.0000) in the near future has grown markedly on this week’s breakdown, as the disparity between the ECB’s consistently dovish policy stance and the Fed’s Trump-driven hawkishness has become increasingly evident.

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