Dollar waits for Fed. Forecast as of 02.05.2022

Fed hasn’t been that aggressive for a long time. Expectations of a quick bringing of the Fed’s rate to a neutral level and a massive reduction in the balance sheet lead to turmoil in the securities markets. How does this affect EURUSD? Let us discuss the Forex outlook and make up a trading plan.

Weekly US dollar fundamental forecast

The Federal Reserve’s favorite inflation measure, the core personal consumption expenditures price index, increased by 6.6%, its highest annual level since 1982, making the US central bank act aggressively. The derivatives market expects the federal funds rate to rise to 3%-3.25% by the end of 2022, which creates an ideal environment for the US dollar. In April, the 10-year Treasury yield rose at the fastest rate in 13 years, and the S&P 500 posted its worst monthly performance since October 2008. The stock index hasn’t started a year this badly since 1939.

Rising Treasury yield and sell-offs in stocks encourage the EURUSD bears. The pair is trading at a five-year low that could quickly turn into a 19-year low. And while euro-area inflation accelerates to a new all-time high of 7.5%, allowing the ECB Vice President Luis de Guindos to speculate about raising the deposit rate in June and the currency bloc’s GDP expanding by 0.2% in the first quarter. Investors, however, have little trust in the euro-area economy.

Dynamics of euro-area inflation

Source: Bloomberg

Markets are rising on the news, and the euro-area economy is expected to slide into a recession earlier than the US. Russia has halted gas exports to Poland and Bulgaria, ramping up the pressure on all EU states to find alternative suppliers. The region will need a few years to organise new supplies of gas. If the Russian natural exports to Germany and Italy are also cut off, the recession in the euro area will be inevitable.

The US economy could also suffer a downturn. According to the former FOMC officials, there are hardly any chances for a soft landing when the Fed is trying to curb inflation. However, Jerome Powell and his colleagues are pretty optimistic. According to a median gauge of Bloomberg experts, the Fed will raise the rate to 2.5% by the end of the year. The US borrowing costs could reach their peak of 2.9% in 2023.

Forecasts for federal funds rate


Source: Bloomberg

Treasury yield is rising, and the US stocks are falling so fast because the central bank is willing to deliver a double blow. Together with the interest rate hikes, the regulator is willing to reduce assets on the balance sheet by $95 billion a month, starting in June or even May, which will be announced at the next FOMC meeting. In the previous cycle, the Fed started allowing $10 billion a month of rolling off and eventually ramped it up to $50 billion a month. Furthermore, the Fed paused the cycle of rate hikes in 2017 to avoid doing too many things at once.

Now the situation is different. The Fed is catching up with inflation, and an energy crisis is pressing down the euro-area economy. In addition, the COVID-19 outbreak in China is slowing down the Chinese economy and inflating consumer prices all over the world due to supply chain disruptions.

Weekly EURUSD trading plan

I suppose the EURUSD should continue falling until the outcomes of the FOMC meeting on May 3 – 4 are published. Next, the shorts will be exited. Hold down short trades entered on the correction to 1.06 and add up to them if the price breaks out the support at 1.049. The downside targets are 1.0414, 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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