Dollar shakes things up. Forecast as of 06.04.2022


Talks about the speedy unwinding of the Fed’s balance sheet, a new round of geopolitical risks, and growing chances of a Eurosceptic victory in the French presidential election press down the EURUSD. Let us discuss the Forex outlook and make up a EURUSD trading plan.

Weekly US dollar fundamental forecast

The EURUSD has been down for several reasons. There are new sanctions against Russia, which could press down the euro-area economy, and the epidemiological situation in China deteriorates. Furthermore, the Eurosceptics could win the presidential elections in France. The probability that Emmanuel Macron will win the second round of the presidential elections in France has fallen to 53% from 60% a month ago. The nationalist leader Marine Le Pen might win as well. The cost of hedging the euro is rising while the price could head for $1.08.

Dynamics of EURUSD and euro risk reversals

Source: Bloomberg

The EURUSD has been down below 1.09 not only because of the euro problems. The greenback again is taking advantage of old drivers, such as the demand for safe havens because of a new round of geopolitical risks and divergence in the monetary policies of the Fed and the ECB. It would seem that FOMC officials couldn’t sound more hawkish than they did. Investors are sure that the Fed will hike the federal funds rate by 50 basis points in May and quickly bring it to a neutral level. However, Federal Reserve Governor Lael Brainard has encouraged the dollar buyers.

She noted that the task of reducing inflation pressures is “paramount,” so the FOMC will need to continue tightening monetary policy methodically through a series of interest rate hikes and by starting to reduce the $8.9-trillion balance sheet as soon as at the May meeting. The balance sheet unwinding pushes up the Treasury yields and makes the stocks overvalued, encouraging investors to sell the securities amid the fall in stock indexes. Therefore, the greenback is strengthening.

The Fed seems to be the most hawkish since a long time ago. According to Deutsche Bank, this will lead to no good. The bank predicts a recession in the US economy next year as the federal funds rate should rise by 50 basis points at three subsequent FOMC meetings and increase to 3.5% by mid-2023. At the same time, the Fed will reduce the balance sheet by $2 trillion by the end of next year, which is equivalent to 3-4 acts of monetary restriction at 25 basis points. The inverted US yield curve also signals a pending recession.

Dynamics of US yield curve

   

Source: Bloomberg

Despite a favourable environment for the US dollar, BNY Mellon claims that the rally in the USD index is coming to an end. Other central banks will also tighten monetary policies, so their currencies will be strengthening against the greenback.

Weekly EURUSD trading plan

Although the strategy to sell the EURUSD at level 1.1165 and add up to the shorts at 1.1055 and 1.1035 yields a profit, the further decline of the pair could be limited. Sanctions are not as terrible as their expectations. The minutes of the FOMC meeting are not as scary as investors think. The idea to sell the euro on the news and buy it on the facts could cause the price to rebound from the zone of 1.084 – 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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