The acceleration of US inflation suggests the Fed will not pause monetary tightening. Furthermore, the US central bank should be tightening monetary policy more aggressively. How will this affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
The US inflation report for May made the Fed worry. The consumer price index increased 8.6% in May from the same month a year ago, marking the highest reading since December 1981. Further growth in energy prices can push the CPI to 9%. Inflation is accelerating. Thus, the Fed will have to tighten its monetary policy more aggressively. This news will push the US stocks down and the US dollar up.
The University of Michigan consumer sentiment data encouraged investors to sell the EURUSD and S&P 500. The three-year indicator rose for the first time since January, from 3% to 3.3%, and the annual rate increased from 5.4% to 5.5%. The Fed cannot rely on inflation expectations, which have peaked since 2008, as an anchor. Their further growth can become a self-fulfilling prophecy regarding future inflation, so the central bank is forced to be proactive. Barclays and Jefferies said that already on June 14-15, the Fed will raise the rate by 75 basis points, and the derivatives market estimates the chances of such a move as fifty-fifty.
I think Jerome Powell and his colleagues will not shock the financial markets with a huge move at the next FOMC meeting but will sound more hawkish. In fact, the Fed has a far more effective weapon than a 75 bp increase in the federal funds rate. Once, Ben Bernanke, a former Federal Reserve chair, said that monetary policy is 98% communication and 2% action. A hint at a big move in the future will tighten financial conditions more than an actual move in June. At present, St. Louis Fed President James Bullard has said that the markets respond to the slightest Fed action.
Forecasts about the future value of rates have more weight than the increase in borrowing costs at a particular FOMC meeting. After the release of US inflation data for May, investors realized that the medians expected by Bloomberg experts of 2.6% and 3.1% in 2022 and 2023, respectively, are far from the limit. The federal funds rate could rise higher. And this circumstance results in the EURUSD drop below 1.05.
The higher is the borrowing cost, the lower are stocks, and the more likely is a recession. The US dollar is strengthening in such an environment, negatively affecting corporate reporting. According to Kyriba, a rally in the USD index will reduce the profits of US companies by $40 billion in the first half of 2022. In January-June 2021, it was about $8 billion. Therefore, the S&P 500 is naturally falling.
Weekly EURUSD trading plan
The market is spiralling. The greenback is strengthening, pressing down the stock indexes. This, in turn, leads to a further USD increase amid lowering risk appetite. I suggest holding the EURUSDshorts entered at the breakout of the support at 1.061 and adding up to them on the corrections.