The Fed hasn’t tightened monetary policy that aggressive for more than two decades. But some analysts criticise it for being too slow. Let us try to find out the real situation and make up a EURUSD trading plan.
Fundamental US dollar forecast today
Buy the news, sell the fact. The matter is that investors are too nervous and could start sell-offs before the expected event happens. I call this a rehearsal of the performance. It is what happened ahead of the release of the FOMC meeting outcomes. US stock indexes were up, and EURUSD featured great volatility, jumping up to 1.058 and going down to initial positions.
Based on the CME derivatives signals, the Fed will raise rates by 50 basis points, which has not happened since 2000. The rate is expected to rise by half a point not only in May, but also in June, and then in July. Moreover, traders are speculating about the possibility of a 75-basis-point rate hike, which last happened in 1994. Simultaneously with the increase in the rate, the Fed intends to reduce the balance sheet, which is almost $9 trillion. It will be shrinking by $95 billion a month. In the previous monetary policy tightening cycle, even at the peak, it was almost half as much.
Dynamics of Fed balance
The markets have not seen such an aggressive monetary restriction for a long time, it is not surprising that stocks are sold. The S&P 500 has lost about 12% of its value in 2022, and the Bloomberg US Aggregate Bond Index, which includes Treasury, corporate, and mortgage bonds, is down 10%. This puts stocks on the path of the biggest simultaneous decline since 1976. The last time stocks and bonds sank together was in 1994.
Market trends explain why the Fed got inflation so wrong in the last year. Some analysts criticise the Fed for wishful thinking slow and having to catch up with the reality now. For a long time, the Fed insisted higher inflation was “transitory” even as evidence accumulated that it was not. After the US central bankers had admitted the problem, they did not act as though they meant it. It took another four months to end its monthly injection of $40bn into the markets that were already booming. Even after proclaiming a turn in the cycle of interest rate hikes, Jerome Powell signalled the shift would be modest.
I suppose that the Fed was in no hurry to tighten its policy, being afraid of a taper tantrum, like in 2013. As the hawkish stance has been expressed more and more often, investors are coming to expect three half-point rate hikes. Now, the odds for the Fed are that the American economy will either run too hot, in case the rate hikes fall short of the expectations, or too cold if the monetary tightening turns out too aggressive.
Weekly EURUSD trading plan
The Fed faces a hard choice, but I don’t think it will signal a 50-basis-point hike in June, otherwise, traders will be exiting the shorts on the EURUSD and stocks. The performance, having been rehearsed, will take place. However, exiting shorts could encourage traders to sell the euro at favourable prices. After all, I suggest buying the EURUSD in the short term unless the price consolidates below 1.049. Going down below this level and then returning above it during the press conference of Jerome Powell is a reason for short-term longs. If the bulls fail, the price will drop to1.041 and 1.032.
Price chart of EURUSD in real time mode
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