The Treasury yield curve could be inverted, signalling a pending recession while the US stock indexes are rallying up. Which signal is accurate? Will there be a recession? Let us discuss the Forex outlook and make up a EURUSD trading plan.
Weekly US dollar fundamental forecast
According to Barclays, if in the short term strong demand for safe-haven assets supports the US dollar, then in the future, the continuation of the global economic recovery and the improvement in global risk appetite will press it down. In the second half of the year, the US economy will lose its exclusivity, and excessive trade deficits and speculative greenback longs will send the US currency down. Looking at the US stocks rally, the forecast seems to be coming true.
After a short pause caused by Jerome Powell’s hawkish comments, US stocks resumed growth, which is usually interpreted as an improvement in global risk appetite. Frightened by the speech of the Fed Chair, investors try to spot some positive in his words. For example, Powell dismissed fears of a recession, citing the experience of 1965, 1984, and 1994, when the central bank cooled the economy but did not provoke a recession, which encourages the buyers of the S&P 500 and EURUSD.
Some analysts suggest that Powell wanted to warn investors against the desire to buy anything, which was clear in the week ended March 18. I believe this process is natural. Investors sell bonds and buy stocks. The Bloomberg Global Aggregate Index, a benchmark for government and corporate debt total returns, has fallen 11% from a high in January 2021. That’s the biggest decline from a peak in data stretching back to 1990, surpassing a 10.8% drawdown during the financial crisis in 2008.
When Treasuries are falling in price, the yields, conversely, grow, and stock prices are also rising, which means some optimism about the prospects of the US economy. This contradicts the yield curve, reflecting the difference between the yields on 10-year and 2-year, which is about to invert. When the indicator goes down below zero, the likelihood of recession increases. This is exactly what happened in all cases of yield curve inversion over the past 40 years. Moreover, Bank of America notes that inverted 10/2 curves have preceded the last eight recessions and 10 out of the last 13 recessions.
Thus, while the stock market is full of bright hopes, bonds are sounding the alarm. Investors fear that the Fed, which has delayed raising rates for too long, will act super-aggressively and eventually lead the US economy into recession. Following James Bullard, who called for raising borrowing costs to 3% as early as 2022, Loretta Mester also sounds rather hawkish. Cleveland Fed President suggests hiking the rates to a neutral level of 2.5% this year and continuing to raise it in 2023.
Weekly EURUSD trading plan
The EURUSD bulls, supported by the S&P 500 rally, have driven the price above 1.1. The idea of consolidation in the range of 1.085 – 1.125 can make sense. If the price breaks out the resistance at 1.105, it could continue rising.