Before the conflict in Ukraine, investors were discussing the reversal of the EURUSD trend up. Let us discuss the Forex outlook and make up atrading plan.
Weekly US dollar fundamental forecast
Evidence requires facts. And they continue to come, convincing in the continuation of the EURUSD downtrend. I have many times stressed that the main drivers of the strengthening of the greenback against the euro are the strong demand for safe-haven assets, lack of dollar liquidity, and, finally, the divergence in the monetary policy of the Fed and the ECB. Different courses of central banks’ monetary policies keep the major currency pair under pressure.
Jerome Powell’s speech before Congress must have ended the debate on exactly how the Fed intends to act. The Fed Chair said he would propose to the FOMC to raise the federal funds rate by 25 basis points in March. He expects a series of increases and is ready to act aggressively if inflation continues to accelerate or shows signs of being at a high level for longer than expected. Thus, the Fed will start tightening monetary policy slowly but then is ready to speed it up, which strengthens the dollar against a basket of major currencies.
The derivatives market expects the federal funds rate to rise by 140 basis points by the end of the year, and the rise in Treasury yields in response to Jerome Powell’s speech suggests that investors are willing to sell bonds, despite the war in Ukraine. Treasury yields are likely to continue the rally, which, in the context of fixed inflationary expectations, leads to an increase in the real Treasury yields, widens its spread with foreign peers, and contributes to the strengthening of the USD index.
How can the ECB respond? At first glance, another, fourth consecutive record rise in consumer prices in the euro area to 5.8% leaves the central bank no choice. It is necessary to finish the QE and move on to raising rates! However, things are different. Tighter monetary policy risks setting back the economic recovery, which, has been already weakened due to the crisis in Ukraine. Not surprisingly, Philip Lane, who was talking about normalization a couple of weeks ago, is now saying that the central bank is closely monitoring developments in Eastern Europe and will do everything necessary to support the recovery of the currency bloc’s GDP.
According to the chief economist of the ECB, the current weakening of the euro is nothing more than the end of the strengthening that took place in the first year of the pandemic. As a result, the euro exchange rate is not far from pre-COVID-19 levels. The European regulator does not care about the drop of EURUSD, which, according to Deutsche Bank, is one of the factors for rising inflation and is not willing to normalize monetary policy. Therefore, the euro bulls are set back.
Weekly EURUSD trading plan
Therefore, the divergence in monetary policy contributes to the EURUSD downtrend, which could accelerate if the US jobs report for February is strong. I recommend holding shorts entered at 1.126 and 1.117 and adding up to them from time to time.