The June US inflation report makes the Fed act more aggressively. Markets expect the rise in the federal funds rate by 100 basis points. How will this affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
The euro has reached parity with the US dollar for the first time in almost two decades. And this is not only a story of interest rates and different paces of monetary tightening by the Fed and the ECB. Multiple factors are intertwined, including the war in Ukraine, the energy crisis, instability in European debt markets, fears of a recession, and a sharp drop in global risk appetite. Adverse events in the global economy combine to support the greenback, so EURUSD parity does not look like the endpoint of the downtrend. Rather, it is a stop on the way down.
According to the governor of the French central bank, François Villeroy de Galhau, the EURUSD has dropped by 12% since early 2022 not because of the weak euro but because of the strong dollar. The euro trade-weighted exchange rate is down less than 2%, with strong demand for safe-haven assets and aggressive monetary tightening by the Fed backing the greenback. At the same time, the US consumer price growth of 9.1% Y-o-Y, the fastest since 1981, increased the likelihood that the Fed will act more aggressively and raise the federal funds rate not by 75 basis points but by as much as 100 bps! The derivatives market increased the chances of such an outcome to 79%, from 12% before the inflation report.
Such a scenario is suggested by Nomura, and the FOMC officials don’t rule it out. According to Atlanta Fed President Raphael Bostic, all options for the federal funds rate should be discussed. Cleveland Fed President Loretta Mester argues that the latest inflation data gives the central bank reason to raise rates by at least 75 basis points in July. Thomas Barkin is more focused on getting borrowing costs back to neutral as quickly as possible. He acknowledges short-term recession risks but believes it’s better in the medium term if the central bank keeps inflation under control. Given that the neutral level is most likely above 3%, the Fed could hike the rate by 100 basis points in both July and September.
It looks like the Fed understands that it won’t make a soft landing and is ready to force a recession as quickly as possible to eventually bring inflation down. Yes, commodity prices are falling and price growth expectations are slowing down, which increases the likelihood of a CPI peak in June. However, if the central bank acts less aggressively, the US economy could face a third wave of inflationary pressure.
Weekly EURUSD trading plan
Investors wonder what is more important for Europe, the ECB meeting with the first rate increase in many years or the resumption of Nord Stream after maintenance. Will the problems in Italy send the euro into an abyss? Italy has a violent political crisis, and the ECB interest rates could be too high for the country’s public finances. The problem of the euro-area debt market isn’t yet solved. The EURUSD may acquire more bearish drivers. If the price goes back to 1.012, one could add up to the shorts entered at 1.012 and 1.0415.
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