Few people assumed that at the end of 2022 the Fed would begin to signal a slowdown in rate hikes. When this happened, a wave of sales hit the US dollar. However, without the ECB, the picture would be incomplete. Let’s discuss this topic and make up a trading plan for EURUSD.
Weekly US Dollar fundamental forecast
2022 was marked by a massive increase in interest rates. Central banks, seeking to curb demand and reduce inflation, acted according to three criteria. First, how to quickly raise the cost of borrowing. Secondly, how deep inflation can go. Third, how long it will be there. The slowdown in prices makes it possible to reduce the speed of monetary restriction. Both the Fed and the ECB are expected to raise rates by 50 bps in December. Why is EURUSD growing if central banks are moving at the same pace?
In order to predict the future, you need to remember the past. The deepest inversion of the US yield curve since 1981 signals that aggressive tightening of the Fed’s monetary policy will cause a recession in the US. For a long time, the central bank was ready to sacrifice its own economy to defeat inflation. Until now, some economists are not sure that the Fed has changed its stance. 24 of 72 Reuters experts predict that the federal funds rate will rise above 5%.
Others believe that the decline in PCE growth has changed the views of FOMC officials. Now the Fed takes into account bilateral risks. This has led to the USD decline, the advantages of which are no longer beneficial. Moreover, applications for unemployment benefits are increasing, and the growth rate of average wages, according to leading indicators, is decreasing. All this signals a cooling of the labor market. That is, the Fed is effectively doing its job and may soon afford to stick to a wait-and-see approach.
The situation in the securities market confirms that the central bank is also paying attention to the economy. When the Fed was focused on defeating inflation, stocks were falling amid rising Treasury bond yields. Now stock indexes are declining when the Treasury rates are falling. This indicates that money flows from risky assets to safe havens.
Thus, inflated expectations for the Fed’s rate dealt a blow to the greenback. On the contrary, the euro benefited from lowered expectations. Back in early autumn, investors were scared by the energy crisis and predicted a deep recession in the eurozone. Along with the fragmentation of the European debt market, this limited the ECB’s actions. It was assumed that the deposit rate would rise very slightly.
In fact, it rose quickly. A year ago, raising the cost of borrowing by 75 bps at several ECB meetings in a row would have been unimaginable, since in that case the entire financial system would have collapsed. Now it still remains stable.
Weekly EURUSD trading plan
Instead of consolidating ahead of the release of important inflation data and the Fed meeting, the euro is going to update the 5-month high. However, if EURUSD fails to consolidate at 1.058, there will be an opportunity for entering short-term sales.
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