Strong US data made investors doubt the imminent onset of a recession. Perhaps the markets are making a mistake, believing that the Fed will cut rates in 2023? How did this affect EURUSD? Let’s discuss the topic and make up a trading plan.
Weekly Euro fundamental forecast
The Fed has two options. Aggressively raise the federal funds rate above the 5% level expected by the markets, and then immediately lower it if it turns out that the central bank has gone too far. The second option implies a slow approach to the correct level, and then holding the cost of borrowing at this level. At the end of autumn, Fed chose the second option. However, the longer the US economy remains stable, the more tempting it is to return to the first option. It is logical that strong US macro statistics returned interest to the US dollar, putting hopes for a EURUSD rally near the 1.06 mark dashed.
The problem is that financial markets have their own views on Fed monetary policy. Investors are in favor of a combined option. It assumes a slow increase in rates to 5% for several months, and then a decrease. Obviously, this approach is based on forecasts of the imminent recession. This is confirmed by the inversion of the yield curve, and 77% of investors predicting a recession according to the BofA survey. This is the highest level since 2020, when the global economy was shaken by a pandemic.
However, if the US economy continues to improve, the recession may not begin! Then the Fed will have no grounds to reduce the cost of borrowing. It will remain at a high level for a long time, as the central bank predicts. Strong data hints at the mistake of the markets and returns investors’ interest in the US dollar. Why sell USD if rates remain high and continue to put pressure on stocks?
In this regard, the reaction of the markets to the growth of the PMI in the US services sector from 54.4 to 56.5 in November, which is higher than the forecast of Bloomberg experts at 53.5, looks logical. Stock indexes fell, Treasury bond yields rose, and the USD strengthened against major world currencies. Investors began to fear again that the Fed will choose the first option, or will not cut rates at the end of next year.
Exiting speculative long trades also played an important role in the decline of EURUSD. Investors exited long trades. Moreover, the release of November US inflation data and the Fed meeting including updated forecasts for the federal funds rate are expected soon. In Forex, the situation can change dramatically at any minute, so isn’t it better to take what the market gives you and stick to wait-and-see approach?
Weekly EURUSD trading plan
On the eve of important events for investors next week, the risk of EURUSD consolidation is growing. The pair will try to reach its boundaries in the near future. In the meantime, use a breakout of support at 1.0475 to enter short-term sales.