Will dollar give a pass? Forecast as of 16.05.2022

The US dollar is strong. The stock market is down and the risk appetite is low. Furthermore, the euro-area economy is weak. So, the greenback is naturally strengthening. Let us discuss the Forex outlook and make up a EURUSD trading plan.

Weekly US dollar fundamental forecast

Don’t go against the Fed. Anyone who wants to survive in the financial markets must follow this rule like a law. Over the past decade, the Fed struggled with persistently low inflation, which required favourable financial conditions, including low rates, stock market rallies, and a weak currency. In 2021-2022, there has been a tectonic shift when, due to the highest price level in four decades, the central bank needed to tighten financial conditions. The US dollar should be strong, treasury yields should be high, and stock indices should go down. If so, the investment strategies must change radically. Don’t go against the Fed.

Over the past ten years, the S&P 500 has been yielding 17% of annual return. It is clear why the “no alternative to stocks” strategy was popular on the market. Investors used the decline in equities to buy, and the stock indexes were rallying up.

However, the market environment has changed. The FTSE All-World Index has closed for the sixth consecutive week in the red, the longest losing streak since 2008. The S&P 500 has lost 16% of its value since the start of the year, and investors are moving from buying on a decline to selling stocks on a price rise. Moreover, by historical standards, the stocks are still overvalued. According to FactSet, the P/E ratio for securities included in the broad stock index is 16.7. The average value of the indicator for the last 20 years is 15.7. The stock market has room to fall, and therefore the US dollar has room to grow.

The USD rally results not only from the Fed’s willingness to tighten financial conditions and a decline in the global risk appetite but also from the euro weakness.

According to the source of Financial Times familiar with the matter, the European Commission will lower its euro-area GDP growth forecast from 4% to 2.7% in 2022 and raise its inflation estimate to 6%. At the same time, double-digit increases in consumer prices are expected in some countries of Eastern and Central Europe. And even if the inflation forecast for 2023 assumes its growth by 2.7%, that is, the indicator will remain above the ECB target of 2%, the euro can’t be saved by tightening monetary policy. It is not surprising that many Forex analysts expect the EURUSD to reach parity. The options market bets on the euro-dollar parity have increased by $7 billion, and it is the most popular strategy among the derivatives market traders.

Weekly EURUSD trading plan

The euro could be corrected up only if the Fed pauses its aggressive monetary tightening, which will hardly occur until September. The federal funds rate will rise by a point over June and July. Only after that, the Fed will see how inflation is behaving and debate how much higher rates may have to move, according to Cleveland Federal Reserve President Loretta Mester. Therefore, the correction after the breakout of the resistance at 1.042 would be just a temporary break for the EURUSD bears. If the price moves to 1.0475 and 1.051, there could be a new wave of sell-offs.

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