The banking crisis has once again made the idea of a dovish Fed reversal relevant. This weakened the US dollar. However, if the situation stabilizes, the Fed will have no need to cut rates. How will EURUSD react? Let’s discuss this topic and make up a trading plan.
Weekly US dollar fundamental forecast
Is the most aggressive monetary tightening cycle in several decades coming to an end, or are the markets wishful thinking again? According to UniCredit, central banks in the US and the eurozone should avoid raising rates until market stability is ensured. As the leader of the pack, the Fed is obliged to make the first stop, which makes the start of the EURUSD rally possible.
The logic is simple. Bankruptcies force banks to act cautiously and tighten lending conditions, which slows down their volumes and increases the impact of monetary restriction on the economy. As a result, the chances of a recession increase. These processes are taking place all over the world. For example, eurozone banks in February reduced lending to companies by €3 billion, which led to a slowdown in the growth rate of the indicator from 5.3% to 4.9% YoY. The outflow of deposits from the system reached a record level of €71.4 billion. Unsurprisingly, banks have become unstable.
In the US, the banking crisis caused a sharp decrease in the estimated peak of the federal funds rate from 5.75% in early March to 5%. CME derivatives predict it will remain the same at the May FOMC meeting with a 62% probability and expect a decline by the end of 2023 by 100 bps.
However, a day ago it was about 83%. The intention of First Citizens to acquire a significant part of the bankrupt SVB and Deutsche Bank’s strong data calmed investors’ nerves. This increased bond yields and the possibility that the Fed will resume the monetary tightening cycle. The world’s largest asset manager, Black Rock, believes this will be the case. According to it, the markets mistakenly believe the Fed will start lowering rates in 2023 to save the economy. This time, inflation is contained with less struggle but without reducing the borrowing cost.
On paper, this may revive investors’ interest in the US dollar. If the markets expect a dovish reversal, and it does not happen, EURUSD will be under pressure. This had already happened in February, when Jerome Powell delivered a hawkish speech to Congress against the backdrop of accelerating US inflation, and the euro collapsed below $1,055.
Thus, despite the good chances of EURUSD uptrend recovery, traders need to take into account the risks of returning interest to the US dollar in the event of stabilization of the banking system and acceleration of US inflation. If Europe becomes the epicenter of new shocks, the euro will decline.
Weekly EURUSD trading plan
Expect nervous trading. The inability of EURUSD to consolidate at 1.08 may make short-term sales relevant. On the contrary, if everything works out, the price will reach the level of 1.089 in the near future.
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