Each monetary tightening cycle is unique. Inflation, unemployment level, and financial conditions are different. So, it is difficult to make predictions based on history. The Fed will act in a different way. How will it affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Fundamental US dollar forecast today
Jerome Powell’s first term was devoted to fighting recessions; in his second term, he is charged with saving the economy from overheating. The Fed is facing a dilemma that the not new. If the central bank tightens monetary policy too slowly, it will trigger an even greater surge in inflation; if the process goes too quickly, the US economy could slide into another recession. During the previous monetary tightening cycle, the Fed used to be patient and cautious. Now, it has to choose a different path amid a rise in consumer prices to 7%
Already in December, the Fed signaled its intention to act aggressively, predicting three federal funds rate hikes in 2022. At the end of January, markets expect to see four, the first of which should take place in March. Investors expect Jerome Powell to hint at this during the press conference following the FOMC upcoming meeting. Furthermore, analysts discuss a possibility of a rate hike by 50 basis points at once. According to Nordea Markets, this is unlikely because of a tense epidemiological situation resulting in weaker domestic data.
The aggressive tightening of the Fed’s monetary policy was one of the arguments in favor of a sharp reduction in the forecast for US GDP for 2022 by the IMF from 5.2% to 4%. High inflation, supply chain disruptions, and the lack of new fiscal stimulus from Joe Biden were cited as additional negative factors. The euro-area economic growth estimate was downgraded by only 0.4 percentage points, which, at first glance, is a bullish factor for the euro. In fact, the energy crisis and the associated risks of Russia’s invasion of Ukraine are so great that the euro will hardly resume the uptrend soon.
However, neither the economic downturn nor the stock indexes crash seems to worry the Fed. The US central bank has set itself the task to curb inflation, and it will make any sacrifice to achieve this. Earlier, Jerome Powell and his colleagues acted, considering the US stock indexes trends. Now, the situation has changed. Favorable financial conditions, skyrocketing consumer prices, and overvalued stocks mean the Fed will not backstep. After all, the S&P 500 capitalization has doubled over the past three years thanks to the Fed’s massive stimulus. Now, the loss of part of the income is perceived as a small price in the process of fighting for the cost of living for Americans.
EURUSD trading plan today
Despite aggressive claims by James Bullard of four rate hikes in 2022 and Christopher Waller that the Fed may need as many as five, Nomura believes there is little chance of a hawkish surprise at the FOMC meeting. The central bank is unlikely to surprise the financial markets with anything, which will support stock indexes and the EURUSD in the short term. However, the rally potential, in any case, seems to be limited; the higher the euro climbs, the more traders will be willing to sell it. On the contrary, something new from Jerome Powell could send the major currency pair down below 1.127, encouraging investors to enter shorts.