While the market waits for the federal funds rate to fall to 4.8% by the end of 2023 after it peaked at 5.1%, major players expect the opposite. How does this affect EURUSD? Let’s discuss this topic and make up a trading plan.
Weekly US dollar fundamental forecast
The USD’s 20-year high was driven not only by a strong economy and the Fed’s aggressive monetary tightening, but also by a bearish stock market. It signaled a deterioration in global risk appetite and supported demand for the greenback as a safe-haven asset. Although the S&P 500 has risen substantially from its October bottom, there are many signs that it is structurally weak, which creates additional headwinds for the EURUSD.
US employment data put stock indices in an extremely uncomfortable position. It seems that demand in the economy will continue to grow faster than supply. This raises the chances of high inflation and forces the Fed to keep rates high for a very long time, which is bad for stocks. According to New York Fed President John Williams, the central bank should maintain a tight monetary policy for several years in order to bring inflation back to the 2% target.
If the January sharp surge in employment was a one-time, and in the future, the situation in the labor market will deteriorate sharply, and a recession will begin, stocks will suffer as well. This will provoke weak demand and a reduction in corporate profits. S&P 500 companies that receive more than half of their revenue from abroad will show an 8.7% drop in fourth-quarter earnings, while the rest will fall by 3%, according to FactSet. The reason is the strong dollar. Despite the USD index’s 8% decline from its September high, it is still 7.5% higher than a year ago.
Citigroup predicts that the S&P 500 will collapse by 15% by the end of the year. A 10% USD fall is required for the stock index to rise. It’s unrealistic when the Fed raises the borrowing cost to 6%. The company isn’t the only one predicting such a high figure. In recent days, many in the futures market expect the monetary restriction cycle to continue.
While derivatives forecast a rise in the federal funds rate to 5.1%, followed by a cut to 4.8% by the end of 2023, the majority opinion may be wrong. Does smart money choose to increase the borrowing cost to 6%?
This is facilitated by hawkish comments from FOMC officials. Christopher Waller believes that the central bank will fight inflation for a long time, which will cause higher rates than the market currently expects. According to Minneapolis Fed President Neil Kashkari, the Fed needs to do more to bring the labor market into balance.
Weekly EURUSD trading plan
Thus, the 2022 USD advantages are returning, and the euro cannot resist them. A further US CPI slowdown could push EURUSD higher towards 1.085. Otherwise, expect it to reach level 1.06. In the meantime, it is reasonable to focus on intraday trading.