If, following an impressive US jobs report, US inflation is also high, the Fed will be likely to raise the federal funds rate by half a point in March. How will the EURUSD react to the US CPI? Let us discuss the Forex outlook and make up a trading plan.
Fundamental US dollar forecast today
There is another calm before a storm in Forex. The EURUSD bulls were not supported by the US stock indexes rally and a drop in the Treasury yields. German bond yields were declining faster than Treasury yields amid the fears of the ECB’s possible mistake. The major currency pair is trading flat in the range of 1.14 – 1.145, waiting for the release of the US inflation data. Both the euro and the dollar have reasons to weaken.
According to the median forecast of Bloomberg experts, US consumer prices accelerated in January from 7% to 7.2%, which is the highest level since the beginning of 1982. Higher CPI growth will increase the chances of a federal funds rate hike by half a point in March. Neither Loretta Mester nor Raphael Bostic wanted to rule out such a move by the central bank, although the Cleveland Fed President finds no good reason for it. The Atlanta Fed President noted that everything would depend on the data, which increases the significance of the inflation data for January after an impressive US jobs report.
However, both Mester and Bostic believe that consumer prices in the US will gradually slow down due to talks about the federal funds rate hike. This could happen already in January. The CPI growth of 7% or less is a reason to sell the US dollar due to concerns that the Fed will not be as aggressive as expected. In my opinion, even if inflation grows to 7.2%, it will provide only temporary support to the greenback. Too much positive has been price in the dollar quotes.
In the future, the EURUSD trend will depend on other factors. For example, they could be capital flows and the fact that the euro is fundamentally undervalued. Goldman Sachs notes that in terms of purchasing power parity, the major currency pair should be trading at 1.3. At the same time, a sharp reduction in the share of European bonds with negative yields will contribute to the inflow of capital into European markets from the asset managers who can’t hold assets with negative yields in their portfolios. I agree with the bank and want to add that the lower share of technology companies in European stock indexes compared to US ones will open the door for the flow of capital from the US to the euro area amid rising global bond market yields.
Nonetheless, I don’t think the EURUSD will be rallying up without any troubles. The imposition of US sanctions against Russia is fraught with inflation acceleration and a GDP downturn in the euro area. Concerns about ECB’s potential policy mistakes will force Christine Lagarde and her colleagues to act patiently and cautiously. The European Central Bank will try to avoid the mistake of 2011 when the rate hike resulted in the euro-area debt crisis.
EURUSD trading plan today
I still believe that the EURUSD downtrend has turned up, but a breakout of the support at 1.14 could send the pair down to 1.135 and 1.13, where one could consider purchases. It will also be relevant to buy if the price breaks out the resistance zone 1.145 – 1.1455.