Some analysts suggest that the divergence in monetary policies of the Fed and the ECB has been priced in the EURUSD exchange rate, which will support the upward correction in the medium term. Has the greenback got other benefits? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
History develops in a spiral. In the 1970s, governments pressured central banks to curb inflation. When the inflation declined, the era of ultra-low interest rates came, which completely suited the government then. Governments stopped interfering with the activities of central banks, supporting the idea of their independence. The rise in inflation in 2021 suggests that the old days are returning. And this can be another greenback’s benefit.
When the economy and financial markets return to normal, the time comes to normalize monetary and fiscal policy. The reduction of fiscal stimulus has an impact on economic growth. According to the December forecasts of Reuters experts, the US GDP in the first quarter will slow down from 6% to 4%, in 2022 – from 5.6% to 3.9%. The estimates included a $1.75 trillion additional bailout package from Joe Biden, but if the bill fails to pass through Congress, the GDP rate will be even lower.
At first, the greenback declined after Senator Joe Manchin, a key centrist, opposed Joe Biden’s plan. The reason is a drop in Treasury yields, as investors, concerned about the US GDP downturn, started buying out the securities actively.
However, a decline in the GDP growth rate and corporate profits, as well as the Fed’s aggressive monetary restrictions, should lead to the S&P 500 correction. It is usually interpreted as a deterioration of global risk appetite, increasing the demand for safe-havens, including the US dollar. Historically, January is the worst month for both the US stock index and the EURUSD pair, which proves their correlation.
The first sign of an impending turmoil is that the strategies of buying the US stocks on the drawdown, popular throughout 2021, are no longer working. The S&P 500 has been down 1% or more twice in a row at the end of December, which didn’t happen before. Up to this point, the drop in the stock index by 1% or more at the end of the trading session was fully covered by its growth the next day in 68% of cases.
I suppose the main growth driver of the US dollar against a basket of currencies in the first half of 2022 will be the understated expectations of the derivatives market regarding the timing and speed of tightening of the Fed’s monetary policy. A shift in the expected date of the first rate hike from June to March and an increase in long-term forecasts for the federal funds rate from 1.5% to 2.5% will help restore the EURUSD downtrend. Furthermore, the S&P 500 correction will also support the greenback.
Weekly EURUSD trading plan
The EURUSD short-term trend will depend on whether the bulls consolidated the price above 1.1225-1.123. If they do, the price will be consolidating in the range of 1.123-1.145. If they don’t, the downtrend will continue.