Divergence in the economic expansion is a reason to sell the EURUSD. However, the Fed’s hawks turn into doves, and the euro bears are set back. Let us discuss the forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
For some traders, the US dollar exchange rate is a puzzle; for others, the dollar price is, on the contrary, a clue to whether the Fed is right saying that the consumer price surge is temporary. If the Fed is wrong, and US inflation should be high for a long time, the central bank will have to raise the interest rate, supporting the dollar rally. Otherwise, if the Fed is right, the dollar will not rise even amid the US economic strength. I am glad about such a trend. The forex pricing again depends on the monetary policy, rather than trade wars or pandemics.
The Fed is the primary obstacle setting back the EURUSD bears. If the US central bank acted in the old way, one could safely trade the ideas based on the dollar smile theory. The dollar smile theory suggests the greenback should strengthen at the recession peak amid high demand for safe-havens, and then the dollar goes down amid aggressive monetary stimulus. Finally, at the third stage, the USD again should rise as the US economy leads ahead of other advanced economies.
To weaken the dollar, global GDP should be recovering evenly. However, the availability of vaccines and epidemiological conditions are different in different countries. So, the global economic recovery will hardly be even. According to Bloomberg research, rich countries will reach the vaccination level of 70-85% of the population required to return to normal life in August, the poor – only in 2024.
Forecasts for reaching herd immunity
In March, the US position looked as exclusive as that of China, having effectively managed the pandemic during most of 2020. As a result, the greenback grew amid the US exclusivity just as the yuan did last year. In April, the dollar faced serious competition as the vaccination campaign progressed in the EU. Investors expect the growth gap between the EU and the US should narrow. However, the services PMI data prove the opposite. The US PMI is close to the highest levels since 1997, while the euro-area PMI doesn’t show consistent growth.
Dynamics of services PMIs
Source: Wall Street Journal
If the Fed in such conditions used the classical approach of the rate hikes, which Janet Yellen reminded about just the other day, I would not hesitate to recommend selling EURUSD. However, the Fed believes that strong economic growth is needed to offset the shock resulted from the pandemic, so monetary policy will remain ultra-easy for a long time. When the Fed hawks turn into doves, the dollar is pressed down.
Weekly EURUSD trading plan
I believe the market should continue testing the Fed’s strength. The US April jobs report will be a good test. Strong employment data will increase the risk of the Treasury yield growth and the EURUSD drop towards 1.196 and 1.193. Otherwise, if Treasury yields do not react, the euro will rise to a level above $1.2045.
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