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The higher the expectations for a dovish Fed reversal, the weaker financial conditions. The more likely it is that rates will rise and the FOMC will turn hawkish. Let’s discuss this topic and make up a trading plan for EURUSD.
Weekly US dollar fundamental forecast
A week ago, the Fed was scared by tightening financial conditions due to the rapid rally in Treasury yields. However, US central bank officials are now afraid of the reverse process. A sharp drop in rates on the debt market and the US dollar and the growth of stock indices make it difficult for the central bank to fight inflation. Not surprisingly, hawkish FOMC officials attempted to lower market expectations of a federal funds rate cut from 4.5% to 4.75% in 2024.
Michelle Bowman said the 4.9% GDP expansion in the third quarter is evidence that the economy is accelerating and requiring higher borrowing costs. Dallas Fed President Lorie Logan argues that inflation has a better chance of settling near 3% than falling to 2%. To return it to the target, more stringent financial conditions are required. After the disappointing US jobs report for October, they have seriously weakened.
Dynamics of US financial conditions
Source: Nordea Markets.
History repeats itself. According to Deutsche Bank, this is the seventh time in the current monetary tightening cycle that the market is betting on a Fed’s dovish reversal. Previous assumptions were wrong, as expectations of monetary expansion weaken financial conditions and force central bank officials to raise borrowing costs. Once they pause, investors consider the cycle complete and predict rate cuts. This can be repeated many times.
Dynamics of the Fed rate and expectations for its change
Source: Bloomberg.
According to derivatives, the Fed funds rate will fall by 92 bps in 2024. However, this requires a recession. Although the US jobs report for October turned out to be disappointing, it cannot be called weak. Before the pandemic, non-farm payrolls were growing at the same pace as now.
It is quite possible that the markets could not cope with their own emotions after the reduction in bond issuance by the Treasury, the Fed’s hints at ending the monetary restriction cycle, and lower employment growth than expected. Some investors, acting rationally, exited EURUSD long trades, which led to the pair’s correction. There is logic in this, because Jerome Powell, frightened by weakening financial conditions, may turn hawkish following his colleagues.
The greenback can no longer count on the Fed-ECB divergence in monetary policy. The US-eurozone divergence in economic growth will probably narrow. These factors increase the chances of EURUSD growth. However, only US inflation data for October can answer all questions. A further slowdown in indicators will allow EURUSD to approach 1.09.
Weekly EURUSD trading plan
Now, the euro will have to endure the consequences of Jerome Powell’s speeches. If EUR passes this test, the correction will continue. Cautiously add up to EURUSD long trades entered at 1.0665 on a breakout of resistance at 1.0705 and 1.0725.
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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