Inflation is high, and the Fed doesn’t want to support the stock market. Therefore, the previous pattern may not work out this time. The US central bank is more unpredictable than before. How will it affect EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Monthly US dollar fundamental forecast
Every rule has exceptions. The weak start of the US dollar in 2022 was driven by investors’ belief that history would repeat itself. Preciously, the USD peaked at the time of the first federal funds rate hike in the cycle and was moving down afterward. The problem is that in 1994, 1999, 2004, and 2015 inflation in the United States was at the 2% target or slightly below. The Fed took a proactive approach, but now it has to catch up with skyrocketing prices. And Jerome Powell’s press conference following the January FOMC meeting convinced that the central bank would spare no effort to curb inflation. As a result, EURUSD is about to mark the worst weekly close in the last seven months.
Investors believed that the history of the previous monetary tightening cycles would repeat, and the USD index formed divergence with US Treasury yield. Thanks to Jerome Powell’s speech, these divergences were closed, and a positive correlation was restored, spurring the USD index rally.
The derivatives market expects five federal funds rate hikes in 2022; Deutsche Bank shares the same view, predicting a rate increase of 25 basis points in March, May, and June, and two more before the end of the year, which will eventually result in EURUSD reaching 1.1. BNP Paribas is even more aggressive – it hopes to see as many as six acts of monetary restriction. Given that the ECB tended to lag behind the Fed, and when it decided to go along with it in 2008 and 2011, it was seen as a political mistake, divergence in monetary policy is once again one of the primary Forex drivers. If Christine Lagarde and her colleagues decide to start raising rates only in 2023, when the Fed ends the cycle, 2022 will be as bad for the euro as 2021. If not worse.
However, every rule has exceptions. The main reason for the acceleration of inflation at present is problems of supply, not demand. If the central bank presses down demand with aggressive monetary tightening, it could lead not only to a recession but to a doubling of the unemployment rate. And the Fed is well aware of this. Jerome Powell noted that there are many opportunities for raising rates without threatening the labour market. Currently, the Fed has room to maneuver, but what happens in the middle of the year?
In the meantime, investors are willing to buy the US dollar amid the talks about a federal funds rate hike by 50 basis points in March, which will show the Fed’s intention to act decisively in the fight against inflation and its unwillingness to act according to the stock market expectations. In the meantime, investors headlong rushed to buy the US dollar, armed with rumors of an increase in borrowing costs by 50 bp in March, which will show the Fed’s intention to act decisively in the fight against inflation, and seeing the central bank’s unwillingness to handle the stock market. The fall in stock indices is another argument favoring the greenback as a safe-haven currency. Even the acceleration of US GDP to 6.9% in the fourth quarter and to 5.5% in 2021, the best growth since 1984, did not support the S&P 500 and its peers.
Monthly EURUSD trading plan today
Thus, Jerome Powell encourages the EURUSD bears. Nordea Markets forecast of 1.085 by the end of the year no longer looks like something fantastic. As long as the pair is trading below 1.133, the euro downtrend will hardly be broken. It is still relevant to sell the euro with a target of $1.1.
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