The EURUSD is about to reach parity, but bears will go ahead. When gas is turned off for Europe, and the Fed is not going to stop, the euro bulls are set back. Let us discuss the Forex outlook and make up a trading plan.
Weekly euro fundamental forecast
The nature of financial markets is such that the longer the exchange rate strengthens, the more significant, faster, and more painful the correction. However, without a trigger, such as the end of the war in Ukraine, which would bring Russian gas back to Germany, or without the Fed’s dovish shift, it’s hard to see what could cause the US dollar to weaken. EURUSD is close to parity and is trading at its lowest level since 2002, and the downtrend is far from being exhausted.
The trade-weighted real US dollar has been above current levels only twice in its history, in 2002 and 1985. It is so high not because the US economy is strong. The competitors just look worse. Investors expect a recession in Europe earlier than in the US. The euro area is an energy importer, the US is an exporter, and at current energy prices, this matters.
The suspension of Nord Stream for maintenance makes Germany afraid that the gas will be shut off for longer than ten days. Germany is trying to fill the gas storage by 90% by November, with the current level of 63%. Obviously, the sooner Russia begins to avenge Western sanctions, the more pain Europe will feel. Most likely, the euro-area economy will plunge into a recession faster than currently expected.
In the US, many indicators also signal a pending recession, but the Fed doesn’t seem to worry. The yield curve, the difference between the yield on 10- and 2-year Treasuries, has inverted. Over the past half-century, the inverted yield curve has signaled an approaching downturn with a time lag of 6-24 months. This puts the US economy on the path to a significant reduction in GDP by early 2024 at the latest. Atlanta Fed’s leading indicator signals a slowdown in gross domestic product growth by 1.2% in the second quarter after a drop in the indicator by 1.6% in the first. Financial conditions are the tightest since the 2020 crisis.
If the Fed believed in an impending recession, it wouldn’t express its concerns aloud to prevent a panic in financial markets. The same was with inflation expectations. The slowdown of the 3-year indicator from the New York Fed from 3.9% to 3.6% in May and the 5-year indicator from 2.9% to 2.8% signals a small victory for the Fed.
I don’t think the Fed will slow down monetary tightening due to a potential decline in the core inflation from 6% to 5.7% in June. The money will continue flowing into the US because its assets are more attractive to investors. A wide gap between US and Germany bond yields supports the US dollar.
Weekly EURUSD trading plan
The growth gap between US and euro-area economies and the Fed’s more aggressive monetary tightening compared to the ECB’s send the EURUSD down to 0.985 and 0.95. I recommend holding down short trades entered at 1.0415 and 1.012 and adding up to them on corrections.