In theory, raising rates slows down the economy, which ultimately leads to a weaker currency. However, in practice, each cycle of monetary tightening is unique. And the current one is no exception. Let us discuss the Forex outlook and make up a EURUSD trading plan.
Weekly US dollar fundamental forecast
Investors have been underestimating the US economy so far. The idea was simple: the Fed’s most aggressive monetary tightening should have cooled down the economy and pushed it into a recession. That’s what the theory says. However, any theory is nothing without practice. The real world is different, and the positive US domestic data have discouraged the EURUSD bulls.
Following strong reports on the housing market, durable goods orders, and consumer spending, investors were motivated by the revision of US GDP growth for the first quarter from 1.3% to 2% and the decrease in the number of jobless claims. The labour market is still strong, economic growth is above the expected trend, and inflation remains at elevated levels. Such a combination, according to Jerome Powell, opens the door for at least two federal funds rate hikes. Not surprisingly, the chances of it increasing to 5.75% or more by the end of 2023 have increased from 10% to 36%, and Treasury yields have jumped. These are bullish drivers for the US dollar.
When the interest rates were very low during the decade between the 2008-2009 global financial crisis and the pandemic, the idea of raising the federal funds rate to 5% seemed unreal, according to the Fed chairman. Now the central bank wonders if the monetary policy is restrictive enough. The aim of Jerome Powell and his colleagues is not a certain number of rate hikes but the search for a rate that would slow inflation to 2% without causing serious shock to the economy.
Judging by the slowdown in consumer price growth and strong domestic data, the Fed is doing well so far. The US economy looks better than the rest, and if they continue like this, US exceptionalism will bring EURUSD back to the lower end of the 1.07-1.1 range.
How can the euro respond? The hawkish stance of the members of the Governing Council? Accelerating German inflation to 6.8% in June? What seemed significant a couple of days ago, today, does not look so. On the sidelines of a forum in Sintra, Portugal, European bankers secretly told the Financial Times that they did not want what happened in the UK to happen in the currency bloc. In the UK, consumer prices accelerated contrary to the forecasts of the Bank of England. It’s better to be hawkish and talk about CPI’s sustainability than to be wrong, like the BoE.
As for German inflation, its growth against the backdrop of a slowdown in prices in Spain below 2% introduces a split in the Governing Council. In addition, the euro grew on expectations, and as soon as the data on the German CPI were published, it has been sold off on the facts.
Weekly EURUSD trading plan
Therefore, the US exclusivity, the Fed’s willingness to raise the interest rates to 5.75%, and the split among the ECB members suggest one should hold down the EURUSD shorts and add up to them. The downside targets are 1.0835 and 1.08.
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