EURUSD dreams of impossible. Forecast as of 02.08.2022

Despite the numerous problems in the euro area, the EURUSD is rising. The main reason seems to be the weakening of the US dollar against a basket of currencies amid the higher risk appetite and a revision of the Fed’s monetary tightening pace. Let us discuss the Forex outlook and make up a trading plan.

Weekly euro fundamental forecast

Are financial markets wrong dreaming of the impossible? The S&P 500 rose 9.1% in July, its best performance since November 2020. Stocks and bonds are reassessing the Fed’s monetary policy outlook. Just a week ago, the chances of a 50-basis-point federal funds rate hike in September were 44%, but now they have jumped to 82%. In addition to a drop in Treasury yields, this encourages the EURUSD bulls, but the growth potential looks limited.

The greenback’s safe-haven status and the Fed’s aggressive monetary tightening are the major bullish drivers for the dollar that allowed the USD hit its 20-year high. When both stocks and bonds fall, causing the latter to rise in yield, there is no alternative to the US dollar. However, fears of a recession have lured investors back to Treasuries. Treasury yields went down, depriving the greenback of an important benefit. Bank of America forecasts 10-year yields to drop to 2%. Even if the Fed manages to make a soft landing, market fears of a recession will still have a significant impact.

Therefore, investors sell dollars and buy bonds and stocks, sending up stock indexes and increasing global risk appetite. As a result, even such a vulnerable currency as the euro strengthens versus the US dollar.

The pressure on the greenback is worsened by the talks about a slowdown in the Fed’s monetary tightening. A weak ISM report on the US manufacturing PMI, the worst since June 2020, supports the expectations of a pause in the rate hikes. Furthermore, the Price Index fell by 18.5 points, the sharpest decline since the summer of 2010. If inflation is slowing down and production is about to face a reduction, the Fed will hardly raise the rates that aggressively.

Nonetheless, the US PMI has slipped below the critical 50 mark more than once, even when there was no recession. It was in the critical zone during the last five months of 2019 and the same period at the end of 2015 and the beginning of 2016. The latest data suggest that the PMI is growing more slowly, but it is still growing.

Markets’ expectations complicate the Fed’s work. The S&P 500 rally, the drop in Treasury yields, and the US dollar loosen financial conditions. The central bank, on the contrary, wants to tighten financial conditions to curb employment and wage growth. If it fails, inflation will remain excessively high for a long time.

Weekly EURUSD trading plan

Unless the US stock index continues rallying up, the EURUSD bulls will be discouraged. Investors could be unwilling to take any actions ahead of the US jobs report. The longs entered at level 1.0255 look vulnerable but one could hold them up yet. If the euro goes below $1.018, it will be relevant to sell.

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