Despite the numerous bearish drivers, the EURUSD downtrend doesn’t develop fast. Many advantages of the US dollar have been priced in the quotes of the main currency pair. Or is there another reason? Let us discuss the Forex outlook and make up a trading plan.
Weekly euro fundamental forecast
The euro area is cutting on its own throat, Jerome Powell switches on a hawk, and there is no progress in the negotiations between Moscow and Kyiv, so the EURUSD is naturally going down. The EU members are actively discussing the possibility of joining the US-UK embargo on Russian oil, which pushes the Brent price up and increases the risks of stagflation in the euro area. Christine Lagarde says that even if the most pessimistic scenario, including the lack of oil and gas and continuous conflict in Ukraine, takes place, the ECB still predicts a 2.3% GDP growth for the euro area. However, the markets do not really believe her.
Which economy will go into recession faster? European with its territorial proximity to the war zone and dependence on Russian energy? Or the American one with its aggressive monetary tightening? According to Jerome Powell, if the Fed sees appropriate to raise rates by 50 basis points, it will do so. If the Fed sees appropriate to tighten beyond common measures of neutral and into a more restrictive stance, it will do so. What can stop the US central bank? Nothing! Investors have not seen such an aggressive hawk in the chairman of the Fed since the days of Paul Volcker.
However, Capital Economics notes that since the 1970s, out of 16 episodes when central banks in the US, UK, and the euro area raised rates, 13 ended in a recession. A pending recession is signalled by the US yield curve, the difference between the yields on 10-year and 2-year Treasuries, which is going to be inverted. Nonetheless, Jerome Powell advises investors to look at the yield spread between 3-year and 18-month bonds, which is currently steadily rising.
After all, the US bonds are being sold off. The last time such an increase in Treasury yields as in March took place in November 2016. At the same time, Treasury bonds could perform the worst result since 1973. It is not surprising that speculators were increasing the USD net longs in the week ended March 15 at the fastest pace since the beginning of the year. The euro was being sold off the most. Hedge funds dumped it the fastest since 2018.
On the other hand, even amid so many bearish factors for the EURUSD, the euro doesn’t look too bad. Even Jerome Powell’s pronounced hawkish stance and the associated rally in Treasury yields do not discourage the euro bulls. They are trying to go ahead, which, in my opinion, is connected with a change in the outlook of the derivatives market. CME derivatives do not believe in the Fed’s willingness to raise the rate significantly above the neutral level and predict its cut in 2023-2024
Weekly EURUSD trading plan
Simply put, the Fed has taken an aggressive start but it could slow down the monetary tightening process if the inflation rate is down. Therefore, the EURUSD downtrend is limited. In the meanwhile, it is still relevant to sell towards 1.088-1.092, however, the price can well rebound up from these levels.