A surge in the US inflation to 6.2% caused panic in financial markets. Stocks crashed, Treasury yield has been up amid the expectations of the Fed’s aggressive monetary restriction. How will this affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
The release of US consumer price data for October explains why investors are not interested in the question of whether the Fed will raise interest rates. They are more concerned with how fast the federal funds rate will be raised. Although San Francisco Federal Reserve President Mary Daly said that the “eye-popping” inflation data should abate after pandemic effects wane, and it’s too early to make adjustments to the trajectory of interest rate changes. But the market doesn’t believe her, and investors seem to be right.
According to the Labor Department, consumer prices in October jumped to 6.2%, core inflation to 4.6%, which in both cases is the highest value in more than three decades. The CPI has surpassed 5% for the fifth month in a row and casts doubt on the Fed’s mantra about the temporary nature of high inflation. The derivatives market expects that the central bank will be forced to tighten its monetary policy. CME derivatives give a 64% chance of raising the federal funds rate by June, up from a 51% pre-consumer price data release. The chances of two rate hikes in 2022 increased from 63% to 80%, by three – from 29% to 49%. Therefore, the US dollar has naturally strengthened.
Dynamics of US inflation
The greenback was also supported by the rise in Treasury yields. For 2-year securities, it jumped at the fastest pace since March 2020 and returned to the area of annual highs. A surge in inflation is not good news for debt obligations; in this scenario, the purchasing power of coupons paid on bonds decreases, and the chances of the Fed’s monetary tightening increase.
Dynamics of Treasury yields
Source: Financial Times
The rise in Treasury yields has been followed by the rising yields on other countries’ bonds. In Canada, the overnight rate is now expected to rise by 100 basis points in 2022, and even the ECB, according to markets, may raise the deposit rate next year. This does not contradict the opinion of the governor of the Bank of Austria, Robert Holzmann, claiming that the ECB can completely finish the QE, including the APP, by September. On the other hand, the European Commission is to publish a forecast according to which inflation in the euro area will slow down from 2.4% in 2021 to 2.2% in 2022 and 1.4% in 2023, which implies long-term preservation of the ECB’s ultra-easy monetary policy.
Therefore, the ECB remains patient while the Fed is forced to take action. The US central bank has already expressed its doubts that the surge in inflation will quickly subside. The Fed’s officials suggest the inflation will remain high longer than previously thought. Investors wonder how the Fed can afford to wait at this level of consumer prices. And what exactly is the central bank waiting for? Is it Jerome Powell’s re-election, perhaps?
Weekly EURUSD trading plan
After all, the CPI surge sent the EURUSD down as was expected. The shorts entered at the breakout of level 1.157 ahead of the US inflation report seem to be profitable. The earlier indicated target at 1.145 could soon be reached.
Price chart of EURUSD in real time mode
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