The release of US labor market data prompted investors to take wishful thinking for granted. The probability of a 50-basis-point reduction in the Fed interest rate in September increased to 50% but then declined to 31%. What is the reason behind this change of heart? Let us discuss this topic and make a trading plan for the EURUSD pair.
The article covers the following subjects:
Highlights and key points
- US employment data for August disappointed the markets.
- The labor market is cooling but not frozen.
- The US dollar managed to counterattack.
- A drop in the EURUSD below 1.0665 will allow traders to sell the pair.
Weekly US dollar fundamental forecast
The 142K increase in US employment in August seemed to put the nail in the US dollar’s coffin. This was particularly evident when the June-July data was revised downward by 86K, and the three-month average collapsed to 116K. The probability of a half-point cut in the federal funds rate in September rose to 50%, and the EURUSD pair rallied to 1.115. However, subsequent factors led to a change in this outlook.
US 3-month average employment rate
Source: Wall Street Journal.
The market responds to headlines. In practice, the specifics are the most important. The decline in unemployment to 4.2% from 4.3% and the acceleration in average wages to 0.4% from 0.3% m/m suggest that the labor market is experiencing a softening, but not a worsening, trend. This is a crucial factor for the Fed’s forthcoming decision. FOMC member Christopher Waller provided the following summary of the August employment statistics, which prompted a roller coaster reaction in the EURUSD pair. The probability of a 50 bp rate cut in September has decreased to 31%.
Investors seem to have come to believe that the Fed will begin the monetary expansion cycle at a gradual pace, which has led to uncertainty about the extent of monetary easing that derivatives are anticipating. They have forecast a 225-basis-point decline in borrowing costs within the next 12 months. This appears to be an ambitious projection.
Fed interest rate expectations
Source: Bloomberg.
Markets are understandable. The US Federal Reserve’s monetary restraint cycle in 2022 was insufficiently prompt, allowing inflation to accelerate. Should it continue to decelerate, there is a high probability of an economic recession. Investors are taking a proactive stance, particularly given the support they are receiving from the FOMC doves. According to Austan Goolsbee, President of the Federal Reserve Bank of Chicago, the central bank is not required to await a deterioration in the labor market. To achieve a soft landing, it is essential to anticipate and prepare for potential challenges.
By refocusing the Fed’s attention from inflation to employment, investors can prepare for a less pronounced reaction to the release of US CPI data. The consensus forecast suggests that consumer prices will decelerate to 2.6% from 2.9%. Core inflation is expected to remain at 3.2%. For the EURUSD pair, the outcome of the presidential debate and the ECB meeting will be of greater importance.
The derivatives market is anticipating a reduction in the deposit rate from 3.75% to 3.5%. However, there is a divergence of opinion regarding the European Central Bank’s next move in October. Christine Lagarde’s dovish rhetoric could have an adverse effect on the euro.
Donald Trump’s return to the political arena is also a factor to consider. The Republican’s lag in the ratings behind Kamala Harris negates the Trump trade, a positive factor for the US dollar. Should the 45th president succeed in reducing his handicap, the US dollar will strengthen.
Ratings of US presidential candidates
Source: Financial Times.
Weekly EURUSD trading plan
EURUSD bulls failed to keep the quotes above 1.11, confirming their fading strength. Therefore, if the pair falls below the support at 1.1065, one can open short trades, adding them to the previously formed short positions.
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.