US Vs. Euro Area GDP Divergences Explain Fed’s Hawkish Swift

US GDP outperforms the Euro area as more fiscal stimulus spurs growth. The recent hawkish shift from the Fed is in sharp contrast to the ECB’s dovish stance.

The EUR/USD exchange rate has struggled to find direction recently. It fell from above 1.22 on the back of a hawkish Fed message and rebounded from the 1.1850 area two days later. But since then, it grinds higher, closer to 1.20, and trading with a bid tone.

It may be that in the short to medium term, the exchange rate might even post new highs, but a quick analysis of the fiscal measures in response to the COVID-19 pandemic and the divergence between the two central banks’ messages suggest that any further strength in the EUR/USD rate should be taken with a grain of salt.

Fiscal Stimulus Could Rise Further in the United States

The chart above shows how the world reacted to the COVID-19 pandemic by comparing the fiscal measures taken in response to it. US additional spending and foregone revenues are the most obvious.

Moreover, the new proposals to push forward with an infrastructure investment programme and the American families plan will add an extra $3.8 trillion in further stimulus.

The combination of the above has led to strong growth in the United States – even stronger than expected. The US economy was 3% below the growth trend in Q1 2021, but the Euro area GDP growth was even lower, at 7% below trend.

If we add the continuous fiscal stimulus from the upcoming programmes, the US economy is projected to be back to the pre-pandemic growth trend by Q1 2022. In sharp contrast, this will not happen in the Euro area until 2023 or even later, judging by the latest projections.

As such, the EUR/USD exchange rate should reflect the GDP growth differential. Also, the differential helps explain why the Fed turned modestly hawkish, while the ECB keeps its dovish narrative in place.

Disclaimer: None of the content in this article should be viewed as investment advice or a recommendation to buy or sell. Past performance/statistics may not necessarily reflect future ...

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