Is the Fed wrong in thinking the federal funds rate peak is 3.8%? The markets believe the highest the rate can reach is 3.3%. If that’s true, the USD index will stop rallying. Let’s discuss it and make a trading plan for EURUSD.
Fundamental forecast for dollar for today
Russia is to cut gas flows to Europe through Nord Stream by 50%. Gas prices have soared 12%, expected to grow further in the winter. German DAX is falling, and the German business confidence index collapsed to its lowest since the beginning of the pandemic. However, the euro remains steady against the USD, bewildering investors. The thing is the EURUSD rate is determined in North America, not Europe. Markets are waiting for the Fed’s decision on the federal funds rate and the Q2 GDP report.
The greenback is weakening against other major currencies amid expectations that the Fed is wrong. In its recent forecasts, the FOMC expected rates to grow to 3.8% in 2023. The derivatives market indicates that borrowing costs will rise to their highest at 3.3% as early as 2022. Then the Fed will start restrictions in June 2023, dropping them to 2.5% in 2024. Investors believe the Fed-driven housing market slowdown will affect retail sales and business investment, resulting in cooling GDP and inflation growth pace.
However, not everyone shares that point of view. Morgan Stanley believes it’s just wishful thinking: markets seem to confuse a peak of monetary restriction speeding with ending policy tightening. History suggests that inflation must reach its highest before the Fed stops raising rates. And who said 9.1% is the highest for CPI? Even a recession will not stop the Fed if consumer prices continue rising. A monetary restriction cycle will continue, pushing the USD index even higher.
There’s another option. The US economy may live through an aggressive rate hike against a backdrop of strong household balance sheets and optimistic labor market data. A soft landing would speak about US exclusivity and attract foreign capital, resulting in the greenback’s consolidation.
So, two out of three scenarios suggest that the US dollar should continue rallying and the EURUSD get back to parity. The problem is that slowing down a monetary restriction and a lower-than-expected federal funds rate peak are considered basic scenarios. There’s a USD index reversal in the offing, from which even such a weak currency as the euro can benefit.
Trading plan for EURUSD for today
Investors would like to know if the market consensus meets the Fed’s point of view. They will try to find clues in Jerome Powell’s statement following the 75-point rate hike. If the Fed Head links the FOMC’s future decisions to upbeat US economic data, the greenback will be on sale. If Powell keeps a resolution to fight high prices as an inflation peak is still far, the EURUSD will attempt to reach parity. So, there isn’t much time left. Until then, keep off the market.