Euro looks into abyss. Forecast as of 06.07.2022

The energy crisis, limited capacities of the ECB, and the growing likelihood of the global recession have sent the EURUSD down to the lowest level since 2002. Will the euro recover or continue falling? Let us discuss the Forex outlook and make up a trading plan.

Weekly euro fundamental forecast

The euro is pressed down while the dollar is strengthening. The risks of an impending global recession are running high, the Fed is determined to curb inflation, and the ECB is torn between record-high prices, GDP slowdown, and potential turmoil in the euro-area market. The EURUSD is down to a 20-year low.

In times of crisis, people are willing to buy dollars. Bloomberg models give a 38% chance of a recession in the US, and another yield curve inversion adds to the panic. The narrowing gap between the 10- and 2-year Treasury yields below zero has correctly predicted a downturn over the past half century with a time lag of 2 years. The greenback would hardly be so strong if it were only about the USA. In other countries, the situation is even worse. Over the past sixteen days, gas prices in the euro area have skyrocketed by 100%, so the EURUSD drop to the lowest level since December 2002 can be a clue of what will happen in autumn when the Russian gas supply is shut down.

The relative resilience of the US economy to the energy crisis, strong employment, and the presence of a cash cushion for American households allow the Fed to act aggressively. From the beginning of the pandemic until the end of 2021, the population accumulated additional savings of $2.7 trillion. Families have only spent about $114 billion so far, according to Moody’s Analytics. Yes, a US recession is likely to happen, but it will be mild. However, suppose the Fed makes a pause in monetary tightening too early and doesn’t curb inflation expectations. In that case, the US economy will return to the 1970s when the lack of central bank determination resulted in a need to resort to another, more aggressive, monetary tightening cycle. That resulted in the highest unemployment rates since the Great Depression.

The mistake of insufficient monetary tightening will have serious consequences, which the Fed is well aware of. Although the futures market has cut its forecast for the federal funds rate in 2022 from 3.9% to 3.3% over the past three weeks, it’s still high! Conversely, ECB deposit rate expectations fell from +190 basis points to +135 basis points over the same period. The ECB interest rates will barely reach 1%, while the US rate will exceed 3%. It is a reason to sell the EURUSD.

The ECB capacities are limited. The anti-fragmentation programme being developed may run into legal and political obstacles. Germany and the Netherlands have already warned that the ECB should not encourage fiscal fatigue or indulge in monetary financing of governments, which is contrary to the deal with the EU.

Weekly EURUSD trading plan

The euro’s future looks gloomy. Mizuho sees parity with the US dollar as a matter of time, while Nomura expects the pair to drop to 0.95. I recommend holding EURUSD shorts entered at level1.0415 and adding up to them on corrections.

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