Due to fears that the negative consequences of the rate hike will manifest later, the Fed is slowing down the speed of monetary restriction. However, everything may change if US inflation unexpectedly accelerates in November. Let’s discuss this topic and make up a trading plan for EURUSD.
Daily US Dollar fundamental forecast
The markets react very viciously to the releases of US inflation data. However, the more important question is, how will it change in 2023? BofA believes that it will be easy for the Fed to reduce prices to 3-4%, but it is almost impossible to return them to the 2% target. UBS predicts a slowdown in CPI to 2.1% next year and compares the current situation with the 1940s. Back then, there were also large-scale fiscal incentives, excessive savings and big shocks in the labor market. Inflation jumped sharply, but after a year of growth, it decreased by itself. How will the situation change nowadays?
Now the Fed is trying to be safe. Central bank officials have been saying for too long that prices would fall without intervention, but then the Fed caught up with rapidly rising inflation with sharp jumps. Finally, the regulator decided to slow down the speed, knowing well that it blunders around. Monetary policy affects the economy with a time lag, so it is unknown how the most aggressive restriction in decades will affect the CPI. The Fed believes that the growth rate of consumer prices will decline slowly, and the economy will avoid recession. In this scenario, the rate should be raised to about 5% and kept there until the end of 2023.
The markets think otherwise. In their opinion, inflation will slow down just as fast as it grew in 2022, and the tightening of the Fed’s monetary policy will provoke a recession in the US economy. As a result, the cost of borrowing will have to be reduced at the end of next year. These views contradict history, since over the past five cycles of monetary restriction, rates have been kept at the highest level for 11 months. At the same time, prices were lower than they are now.
When inflation was at its peak, Fed officials were unanimous. As the CPI growth rate declines, the split within the FOMC is getting bigger. Doves call for patience. They are concerned that the central bank may raise the cost of borrowing higher than necessary and provoke an unnecessarily deep recession of the economy. The hawks believe that without a weakening of the labor market, inflationary pressure will remain unacceptably high. Only actual consumer prices data can clarify the situation.
Despite the fact that little depends on one report, the markets vividly react to releases of CPI data. On average, the S&P 500 rose or fell by 3% in 2022, including a 5.5% rise in the stock index on November 10, when data was weaker than expected. Today, Bloomberg experts predict a slowdown in consumer prices from 7.7% to 7.3%, and core inflation from 6.3% to 6.1%. Deviation from the consensus estimate is a reason for wide fluctuations in the stock market and EURUSD.
Daily EURUSD trading plan
If CPI slows down less than expected by analogy with PPI, EURUSD will fall below the supports at 1.052 and 1.05, followed by a rebound from 1.0465 and 1.044. Switch from short-term sales to purchases. On the contrary, a drop in consumer prices by 7.2% or lower will be the reason for entering EURUSD longs.
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