Dollar: curse of labor market. Forecast as of 05.12.2022

On paper, a strong US labor market report should increase the central bank’s aggressiveness, as the Fed’s work has not been done yet and new rate hikes are ahead.  But at the end of 2022, everything happens the other way around. Why? Let’s discuss the topic and make up a trading plan for EURUSD.

Weekly US dollar fundamental forecast

When the Fed was ready to provoke a recession in order to defeat inflation, the market operated according to the strategy “good news from the economy is bad news for stocks.” In this case, the central bank had to continue to aggressively raise rates, which would eventually result in a GDP reduction. Now that the Fed has decided to take into account bilateral risks, good news from the economy is helping US stock indexes. Their dynamics after the strong November jobs report were the basis for EURUSD fluctuations.

The U.S. labor market has been both a blessing and a curse for most of the year. On the one hand, its strength was an optimistic factor, since no one wants a recession. On the other hand, the positive dynamics of the indicators complicated the work of the Fed. In this regard, the November data was bad news for the central bank in its fight against inflation. Employment grew by 263 thousand, faster than Bloomberg forecasts. Unemployment remained at 3.7%. Wage growth accelerated to 5.1%. On a monthly basis, wages grew at the fastest pace since January.

After seeing the strong data, investors began to take profits on EURUSD longs, which provoked the pair to fall to 1.043. The Fed will raise the federal funds rate in December by only 50 bps, taking into account the bilateral risks to avoid a recession, while good news from the economy becomes good for the US stock market. Its growth was a signal of an improvement in global risk appetite and a good reason for USD sales.

The EURUSD rally was based on the unwillingness of the market to change its preferences regarding the fate of the cost of borrowing. Despite the strong employment data, investors still expect that the ceiling on the federal funds rate will be 4.9%, and by the end of 2023 it will drop to 4.4%. No one listens to Fed officials claiming that they intend to keep borrowing costs at a high level throughout the next year.

Why are there such disagreements? In my opinion, the markets believe in a recession, which is confirmed by the inversion of the yield curve. The Fed remains hopeful that the US economy will avoid a downturn.

The euro is supported by expectations of a Christmas rally. In December, EURUSD grew in 15 out of 23 cases since 1999. Its average strengthening by 1.5% is more than double the growth of the second most successful month of the year. However, the situation may change in 2022. After +5% on November, it will not be easy to continue the positive dynamics for the euro.

Weekly EURUSD trading plan

EURUSD is highly probable to reach the previously designated target of 1.061, where it is reasonable to take profits on the remaining long trades. The risks of a correction will increase as the market reassesses employment data and their impact on the Fed’s outlook.

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