Even if the US economy slides into a recession, the Fed will continue rising the rates. This fact will affect the stock and currency markets. In what way? Let us discuss the Forex outlook and make up a EURUSD trading plan.
Weekly US dollar fundamental forecast
The Fed wants to secure a soft landing for the US economy, but the landing will likely be hard. The market sentiment gives a high chance of a recession in the USA and the euro area. This is now a base scenario. The matter is how the Fed will respond to the economic downturn. Will it pause rate hiking or cut the rates? This will determine the trends in many financial instruments, including the EURUSD.
During the speech before the US Congress, Jerome Powell said that even if the US faced a recession, the Fed would continue raising the rates until the inflation rate starts slowing down. Asked by policy-makers what if, in this scenario, unemployment will rise sharply, the Fed Chair didn’t answer immediately. In his opinion, in theory, inflation should fall in this case. In any case, he does not believe that the central bank will start cutting rates.
It seems that the Fed took into account the sad experience of its predecessors. In the 1970s, the regulator also aggressively tightened monetary policy, but not enough to curb inflation. As a result, even tougher action was later required. More and more FOMC policy-makers signal a 75-basis-point rate hike in July, followed by a half-a-point increase in borrowing costs at the next few meetings. Following Neel Kashkari and Christopher Waller, Michelle Bowman expressed the same idea.
Fears that central banks will go too far with monetary tightening and bring the global economy into recession lead to an increase in demand for US Treasuries as safe-haven assets. Rising prices cause yields to fall and put pressure on the dollar. The process is exacerbated by new data indicating that the crisis will soon start. In particular, the US PMI in June went down to a five-month low, and the euro-area PMI dropped to a 16-month low.
Goldman Sachs estimates downside risks in the US over the next 12 months at 30%, Moody’s Analytics at 40%, and Europe is even more vulnerable. It takes good luck to avoid a recession for the global economy, and for the effects of the pandemic and Russian aggression to end quickly.
Investors’ fears result in the sell-off in the US stock indexes. A rise in the stocks is temporary, and traders sell on the price rise. According to research by Societe Generale, the S&P 500 could fall another 24% before the end of 2022. It is based on quantitative analysis, not earnings forecasts and fundamental stock valuation.
Weekly EURUSD trading plan
In early June, investors sold stocks and bonds to buy the US dollar. At present, they are willing to buy Treasuries. The EURUSD bears are discouraged, and the pair is consolidating in the range of 1.045-1.06. I expect the range to widen and suggest selling the pair on the price growth.