Dollar called Fed’s bluff. Forecast as of 06.05.2022

When US indices are down and Treasury yield is up, investors buy cash, strengthening the US dollar. Fed’s monetary tightening fuels this process. Let us discuss the Forex outlook and make up a EURUSD trading plan.

Weekly US dollar fundamental forecast

Following the Fed-driven relief rally, the best rise since 2020, the US stock futures dropped dramatically. Nasdaq Composite was down more than 5%, and the EURUSD rise finished, hardly having started.

Over the past decade, against the backdrop of ultra-easy monetary policy, the Fed and investors have been following the same scenarios. The Federal Reserve stimulated suppressed inflation, and as soon as it started accelerating, it slowly raised rates. Stocks were bought on the dip, and such a simple strategy regularly yielded a profit. In 2022, everything has been turned upside down. The Fed is ready for aggressive monetary tightening, and the associated slowdown in GDP presses down corporate profit growth. Furthermore, Treasury yields are rising, which devalues ​​stocks and makes them look expensive.

When the Fed is withdrawing liquidity from the system and intends to tighten monetary policy even more, and inflation is not slowing down, it makes no sense to buy securities on the fall. It is better to sell them on the growth. This scenario is supported by growing fears of stagflation. An increase in the UBS indicator, signaling the approach of the sluggish economic growth and high prices, convinces of this.

Dynamics of stagflation indicator


Source: Bloomberg 

The increased volatility of stock indexes means that investors called the Fed’s bluff. Jerome Powell said that the 75-basis-point increase in the federal funds rate is not something that the FOMC is actively discussing, but in fact, the faster the central bank acts at the initial stage, the more likely it is to bring inflation under control. Otherwise, high prices could become a long-term environment, making the regulator raise borrowing costs very high. According to ex-Fed Vice Chair Richard Clarida, it is not enough to get the neutral rate of 2.5% this cycle, and the Fed will need to raise interest rates to at least 3.5% to bring surging inflation under control.

In the euro area, the ECB hawks are getting more active, which in theory should support the EURUSD bulls. According to Austria’s central bank governor, Robert Holzmann, the ECB deposit rate could be raised in June, while Luis de Guindos and Isabel Schnabel spoke about July.

Weekly EURUSD trading plan

After all, investors are currently focused on the US economic data. The US jobs report could force the Fed to tighten monetary policy even more aggressively. According to Reuters experts, unemployment will fall to 3.5%, which will complicate the task of the central bank. In such conditions, workers have the right to demand higher wages, which fuels inflation. Employment is likely to increase by 391,000. For the first time in 12 months, it will not add more than 400,000. If the average wage growth exceeds the forecasts, one could consider entering sell trades on the US indices and the EURUSD down to 1.041 and 1.032.

Price chart of EURUSD in real time mode

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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