As expected, US inflation data excited financial markets: the stocks soared while bond yields and the USD fell. Isn’t that reaction excessive? Let’s discuss it and make a trading plan for EURUSD.
Weekly fundamental forecast for dollar
The market’s reaction to the US inflation report made me think about an argument in a couple where each partner repeatedly uses “me” but forgets about “us.” Everyone hears only themselves. The EURUSD bulls are shouting loud that US consumer prices have reached their peak and will continue dropping, meaning the USD index maximum is also left behind. The bears say inflation is still high, and the Fed has much work to do. Speaking about cooling down monetary policy restrictions could be too early, not even mentioning a rate drop in 2023. Everyone is convinced their opinion is right, and there’s no way to a compromise yet. Quarrels are a regular thing in the market.
A slowdown in consumer prices from 9.1% to 8.5% y-o-y in July turned out more significant than Bloomberg experts expected. The indicator has not grown MoM for the first time in two years. Core inflation dropped 0.3% MoM and steadied at 5.9% y-o-y.
A slower growth pace of those indicators relieves the markets, consumers, and businesses, but inflation remains high in absolute terms and has not approached the target of 2%. That’s what President of the Fed of San Francisco Mary C. Daly thinks. She warns that high prices have not been defeated yet. The Fed is still working on it. Daly does not rule out a 75-point federal funds rate hike in September but does not give markets any clear clues.
So, what will be the central bank’s next step? After inflation stats were released, CME’s derivatives downgraded the probability of borrowing costs growth in September by 3/4 points, from nearly 70% to less than 50%. Afterward, Nasdaq Composite rose 20% from June’s lows, putting an end to the longest bearish market since 2008. Bond yields dropped, and the USD retreated, fighting with inner demons.
The inflation values we have seen reduce the risk of a radical 100-point hike but do not rule out less aggressive steps. The federal funds rate will continue growing in 2023. The second half of the next year will not be a period of reduction, as financial markets want, but a period of a plateau. Chicago Fed Chair Charles L. Evans also said the Fed would not stop increasing borrowing costs in 2023. And his colleague from Minneapolis, Neel Kashkari, expects to see the rate at 3.9% by the end of the year and at 4.4% next year.
Weekly trading plan for EURUSD
The EURUSD‘s reaction to the inflation report seems excessive. We expected that, having opened shorts from the level of 1.0355. I recommend holding and building up short positions, also on breakouts of support at 1.018. The bear targets are at 1.01 and 1.