US inflation report for April forces the Fed to raise the rates by half a point at the next FOMC meeting. The US central bank has no obstacles, unlike the ECB. Let us discuss the Forex outlook and make up a EURUSD trading plan.
Weekly euro fundamental forecast
The matter is not whether the US inflation has reached its peak, it is how fast it will decline. That is what investors are worried about. If consumer prices declined fast from the march high of 8.5%, the ultimate Fed’s rate would be lower than currently expected. It would support the stock market and the EURUSD bulls. However, the US CPI report for April hasn’t provided such support.
Inflation slowed down to 8.3%. Inflation in the service sector started to accelerate and is clearly coming from the labour market, where there has been an increase in employment of 400,000 or more for the 12th month in a row. This trend is pushing up wages and fueling consumer prices. Judging by the April data, CPI is more likely to draw a plateau near 8% than to start falling fast. If so, the Fed is forced to aggressively raise the federal funds rate. Continued high price pressure for a long time will mean that borrowing costs in the US may jump to 4% over the next 12-18 months instead of the expected 3%-3.25%. It is good news for the US dollar.
Dynamics and structure of US inflation
The current 8.3% for inflation is a serious reason to raise the rate by 50 basis points at the next FOMC meetings. Even the main hawk, St. Louis Fed President James Bullard, after the publication of the CPI report, says he sees no reason for a 75-basis-point hike. Bullard doesn’t see it at this stage. He still expects borrowing costs to reach 3.5% by the end of 2022.
While the Fed is obsessed with inflation and does not pay attention to either the slowdown in US GDP or the collapse of stock indices or the flattening yield curve, the ECB is forced to act with caution. The euro area is close to the epicenter of the armed conflict in Ukraine, and it depends on Russian oil and gas, facing the associated energy crisis. All these factors increase the risks of recession and stagflation. If the European Central Bank began aggressively raising rates in such conditions, this would push up the European bond yields, making the economic recession start sooner.
Dynamics of central banks’ interest rates
According to Amundi, Europe’s largest asset manager for €2 trillion, as the ECB is focused on maintaining the borrowing costs rather than curbing inflation, the EURUSD should eventually reach parity. If the European Central Bank aimed at pressing down the CPI, it would raise the rate to 1.5% in 2022. Still, the interest rate will just come out of the negative zone this year. In my opinion, there is some sense in this forecast. Once, Christine Lagarde was forced to apologize after she said it was not the ECB’s role to “close the spread” in sovereign debt markets. In fact, it is essential to keep the euro-area bond yields low, especially in the current environment.
Weekly EURUSD trading plan
While the ECB should act with an eye to the economy, facing a risk of recession, the Fed could bring the interest rates up to 4%. Therefore, the EURUSD downtrend will likely continue. If the price breaks out support at 1.049, one could consider entering shorts with targets at 1.041 and 1.031.
Price chart of EURUSD in real time mode
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