Will the Fed raise rates in March or in June? Will US inflation start slowing down in the second half of 2022? Investors don’t believe the Fed’s monetary restriction will be aggressive. How does it affect the EURUSD? Let’s try to answer those questions and make a trading plan.
Weekly fundamental forecast for dollar
Even though the Fed is ready to normalize monetary policy fast, US bond yields are at their all-time lows, the S&P 500 had its 68th record close of the year, and the USD index seems to close its worst week since September. Those are the components of the Financial conditions index. That’s a crucial indicator that allows the Fed to estimate how its forecasts and changes in monetary policy are reflected in the real world. The index is also at its all-time low, which puts a spoke in EURUSD bears’ wheel.
The reasons for the favorable financial conditions and the greenback’s pre-Christmas weakness lie in investors’ low expectations of monetary policy tightening. Derivatives expect the federal funds rate to rise twice in 2022 and have grown to 1.4 % by 2024, although the FOMC forecasted three monetary restriction stages and the growth of borrowing costs to 2.1%. Investors fear that the Fed might finally act less aggressively amid the US economy’s slowdown.
As the Omicron virus strain spreads and Joe Biden’s new fiscal relief aid worth $1.75 trillion has trouble passing through Congress, banks and investment companies downgrade their GDP growth assessments. Oxford Economics forecasts that the US economy will strengthen 2.5% in the first quarter, the previous estimate being 3.4%. Nomura cut their estimates for 2021 and January-March 2022 after consumer expenses were shown to slow down from 1.4% to 0.6% MoM in November.
At the same time, the cut in personal spending is due to inflation, which, according to the Fed’s PCE index, rose to 5.7% in November — its all-time high since 1982.
The Fed’s all effort is currently aimed to combat inflation. Much will depend on when exactly PCE starts slowing down. Particularly, on when exactly the central bank will be able to relax. It’s been strained so far, ready to raise the federal funds rate as early as March. The markets don’t believe the Fed, though: Jerome Powell and his peers have been “doves” for a long time, and their drastic transformation to “hawks” is treated with caution.
Weekly trading plan for EURUSD
The Santa Claus rally lets EURUSD bulls hope the quotes will go beyond the upper limit of the consolidation range 1.1225 – 1.1355. But if they will, the euro growth potential versus the USD looks limited. The US GDP will likely slow down in Q1, but the eurozone’s economy doesn’t look better either. Unlike the Fed, the ECB isn’t planning to raise rates in 2022 and will maintain QE until autumn. In those circumstances, EURUSD will either continue consolidating or be sold on growth to 1.1425 and 1.1455.