Investors were wrong to expect the Fed to slow down the pace of monetary tightening and cut the rates in 2023. The FOMC officials have discouraged them. How will the Fed’s stance affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
Don’t go against the Fed. Investors know this rule but make this mistake over and over again. Markets believed that the central bank, looking at the US economy sliding into a recession, would slow down the monetary tightening pace and even cut the federal funds rate in 2023. In fact, the work of the Fed has not yet been completed, which means that it is not going to stop. It is bad news for the EURUSD bulls.
The major reason for buying the EURUSD was not a strong euro but a weak dollar amid the rally of the US stock indexes and a drop in treasury yields. Markets have ignored Jerome Powell’s numerous references to the latest FOMC rate forecasts of 3.5% in 2022 and 4% in 2023. Investors thought that weak PMI data and lower inflation expectations would make the Fed pause the monetary tightening.
As I noted earlier, the idea of a pause in the Fed’s monetary tightening created an obstacle for the central bank by easing financial conditions, which the Fed wants to tighten. Not surprisingly, even the FOMC centrists began to sound really hawkish in such conditions. Federal Reserve Bank of Minneapolis President Neel Kashkari says the Fed has not achieved its goals. San Francisco Fed President Mary Daly notes the Fed has not completed its task. Chicago Fed President Charles Evans believes that the Fed has an opportunity not to tighten the monetary policy that aggressively, but a rate hike by 75 basis points in September is also acceptable.
Evans expects borrowing costs to reach 3.5% in 2022 and continue to rise in 2023. St. Louis Federal Reserve President James Bullard is more aggressive, he sees an increase in the federal funds rate to 4% this year.
The FOMC officials’ verbal interventions caused the Treasury yields to rise and the stock indexes to fall, encouraging the EURUSD bears.
The derivatives market backstepped. It increased the implied federal funds rate by 12 basis points to 3.4% by the end of 2022 and to 3.27% by mid-2023, from the previously expected 3.02%.
The ECB released data showing its net holdings in German, French and Dutch bonds fell by €18.9 billion in July. Net debt purchases from Italy, Spain, Portugal, and Greece amounted to €17.3 billion. This fact proves that the ECB’s ability to tighten monetary policy is limited.
Weekly EURUSD trading plan
The difference in interest rates in the US and the euro area will support the EURUSD bears for a long time to come. If the US jobs report is strong, the major currency pair will be heading for parity. One could add up to the shorts entered earlier if the price breaks out the supports at 1.0145 and 1.011.