Dollar sends a dovish signal. Forecast as of 05.05.2022

Over the past decade, the Fed used to be dovish; and now it acts hawkish. However, the previous viewpoint should manifest itself, sooner or later. Let us discuss the Forex outlook and make up a EURUSD trading plan.

Weekly US dollar fundamental forecast

Fed wanted to prove its hawkish stance but accidentally sent a dovish signal. Jerome Powell said that an additional 50-basis-point rate hike should be brought up for discussion at upcoming meetings, but a 75-basis-point hike is not something the Committee is actively considering. The derivatives market gave a 95% probability of the first big jump since 1994 in June. That is why the best daily rally of US stocks and a drop in Treasury yields look natural. Traders were exiting the EURUSD shorts, and the price jumped to 1.06.

Before the FOMC May meeting, investors were confident that borrowing costs would increase to 1% and that the process of reducing the balance sheet is about to start. However, the Fed announced it would not get rid of bonds at $95 billion a month, which was another reason for selling the US dollar. In June, July and August, the central bank plans to withdraw assets from its balance sheet for $47.5 billion a month, including $30 billion in Treasuries and $17.5 billion in mortgage bonds. From September, these figures will increase to the previously announced $60 billion and $35 billion per month.

Therefore, the outcomes of the FOMC May meeting are not really dovish. The Fed has just turned out to be not as hawkish as it was expected. The market expectations for the federal funds rate have not been met, encouraging investors to sell the US dollar. Jerome Powell remains set to quickly bring borrowing costs to a neutral level, with CME derivatives projecting a rate hike to 3.25% in 2023.

Can we call the current monetary tightening cycle aggressive? It depends on what we compare it to. If in 2015-2018, borrowing costs increased by 250 basis points, then in 2004-2006 — by 425 basis points. The expected 325 basis points in 2022-2023 are right in the middle. Moreover, the Fed can pause at any time if something goes wrong. And such a scenario is quite likely. For the last ten years, the central bank has been dovish, and now, it is trying to sound hawkish. Sooner or later, the Fed’s dovish manifest itself.

After all, the Fed doesn’t seem to be patient anymore. The central bank wants to curb inflation and avert recession at the same time. The US Secretary of Treasury Janet Yellen says it is quite possible.

The US stock indexes featured the best daily rally, and the 10-year Treasury yield rolled down from the psychologically important level of 3%. The EURUSD soared to 1.06. Traders were exiting shorts, following the principle of buying the greenback on the news and selling it on the facts.

Weekly EURUSD trading plan

Nonetheless, if the price fails to break out the resistance levels of 1.0665, 1.069, and 1.071, it will be relevant to enter EURUSD shorts. There are still more traders who are willing to sell the currency of the region, suffering from serious economic problems and facing stagflation.

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