The Fed tried to avoid the taper tantrum similar to that of 2013 but failed. The S&P 500 dropped, and the Treasury yield, along with the US dollar, has surged. All of this signals the market is in panic. What will the central bank do, and where will the EURUSD go? Let us discuss the Forex outlook and make up a trading plan.
US dollar fundamental forecast today
The Fed acts according to the situation in financial markets. However, amid the highest inflation in the last 40 years, the central bank can’t afford to be cautious. It should turn down the stock and bond market uptrends, as they have grown too much. The regulator should end the wealth effect that has dominated in recent decades, which the Fed has long relied on to accelerate PCE growth. It’s time to take back what the central bank used to generously give. And this circumstance lures investors to the US dollar.
The Fed raises the federal funds rate and is to shrink the balance sheet, strengthening the US dollar against not only currencies but also stocks. After all, the dollar’s profit against Apple stock is a fall in the value of Apple papers. People who invest in them become poorer, they spend less and save more. This is exactly what is needed to curb inflation. Central banks made a big mistake about the temporary nature of high prices and are now forced to act aggressively to regain confidence. The Fed and other regulators made a mistake, and the economy and people are suffering. Well, Jerome Powell warned that they would experience some pain.
Powell used to say that the central bank is not considering raising the rate by 75 basis points at one of the FOMC meetings but did not rule out such a step if conditions change. Jerome Powell played it safe when he laid out a plan to increase borrowing costs by 50 bp in June and then by the same amount in July. He said that everything depends on the development of the economy. Such reservations, against the backdrop of inflation accelerating to 8.6%, allowed the media to make a fuss, and investors believed in a 75-basis-point rate hike on June 15.
Indeed, CME derivatives ahead of the Fed meeting increased the likelihood of the first huge move since 1994 to 89%. But just a week ago, it was less than 4%! So, the USD index returned to 20-year highs, the S&P 500 plunged into a bear market, and the US Treasury yield has performed the best two-day rally since the 1980s.
The Fed tried to avert a repeat of the taper tantrum of 2013 but failed. Amid the expectations of the federal funds rate growth to 4% and the balance sheet shrinking by four world’s leading central banks by $4 trillion before the end of 2023, compared to less than $1 trillion in 2018-2019, the Treasury yield is growing, sending the US dollar up.
EURUSD trading plan today
I suppose the main reason for the dollar rally is the fuss in the media. The market overestimates the speed of the Fed’s monetary tightening. If the central bank raises the rate by just 50 basis points, investors will exit the EURUSD shorts. In this case, one could enter short-term longs if the price breaks out the resistance at 1.0475. However, we should be careful. Fed’s hints at a 75-basis-point rate hike in the future will encourage investors to sell the pair on the price rise.