Dollar is strong as long as war goes on. Forecast as of 14.03.2022


The FOMC meeting is the highlight of the week. Will the Fed worry about a potential recession to start tightening monetary policy aggressively? Where will the EURUSD go? Let us discuss the Forex outlook and make up a trading plan.

Weekly US dollar fundamental forecast

If hawkish sentiments dominate in the ECB’s Governing Council, traditionally dovish, what can be said about the Fed? According to the source of Financial Times familiar with the matter, concerns about accelerating inflation at the ECB March meeting prevailed over problems, including the conflict in Ukraine, uncertainty, and worries about GDP downturn. Conversely, the US economy is robust, with almost 8% inflation, labour market is strong, and the USA is far from the conflict zone in Eastern Europe. Why shouldn’t the FOMC act aggressively?

Dynamics of US inflation

Source: Bloomberg

Central banks are currently facing a difficult choice. Whereas two years ago the pandemic and recession allowed them to act automatically, supplying economies with huge monetary stimulus, now there are hard decisions to be made. Events in Ukraine give rise to bilateral risks: a rise in inflation and a downturn in economic growth. How will the Fed prefer to act in such conditions?

In fact, central banks have fallen into a kind of trap. If the armed conflict in Eastern Europe turns into a long-term event, rising commodity prices will encourage the hawks. If the war ends quickly, everything will return to normal, and the hawks will still go ahead. Financial markets signal the same. In the week ended March 11, the yield of long-term bonds in the US, Australia, Britain, and Europe jumped by 25-30 basis points, yields on 2-year treasuries, sensitive to monetary policy, rose to the highest level since September 2019. The bond market suggests the Fed will choose to curb inflation, rather than prevent a recession. The question is, how aggressive it will be.

CME derivatives expect a 25-basis-point increase in the federal funds rate at the FOMC meeting on March 15-16 and forecast the rate hike by 165 basis points by the end of 2022, which implies six rate hikes at the next seven meetings of the Committee. If Jerome Powell points out that high inflation is creating more problems, this could be taken as a signal for a half-a-point rate hike in May or June, which will encourage the EURUSD bears.

On the other hand, history shows that in the previous eight Fed tightening cycles, the stock market reacted positively, with the S&P 500 up 12 months after they began in all cases. In theory, this should support the euro in the long run.

Response of US stock market to Fed’s monetary tightening

Source: Bloomberg

Weekly EURUSD trading plan

In my opinion, if the conflict in Ukraine ends unexpectedly, the EURUSD could return to level 1.13. However, this does not guarantee the euro downtrend to reverse. The euro-area economy has been badly damaged and will not recover soon. As long as the war goes on, it will be relevant to sell the euro against the dollar, also when the price breaks out the support 1.0885-1.089.

 

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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