The Fed has made its move, and it’s the ECB’s turn now. If the European Central Bank also loses patience and starts fighting with high inflation, there will be turmoil in the market. What about the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Fundamental US dollar forecast today
The hawkish shift in the Fed’s forecasts looked more like panic than a loss of patience, which ultimately ended sadly for the US dollar. But what if the ECB loses patience looking at record-high euro-area inflation? The answer to this question is no less important for EURUSD than the results of the FOMC December meeting.
The Federal Reserve has made it clear that it views inflation as its main enemy and will spare no effort to ease inflation pressure. Officials are optimistic about the future, expecting a slowdown in the core personal consumption expenditures index from 4.4% in 2021 to 2.7% in 2022 and 2.1% in 2023. They intend to achieve such a PCE trajectory with an aggressive federal funds rate hike by 75 basis points in 2022 and 2023, and by 50 basis points in 2024.
FOMC forecasts for interest rates
Source: Financial Times
The fact that most FOMC officials expect three rate hikes next year, while in September, only half of them expected the rate to rise by 25 basis points in 2022, and the second half predicted that this will happen in 2023, investors called the hawkish shift. In addition to a faster tapering of the QE than originally anticipated (in March, not June) and the Fed abandoning the mantra about the temporary nature of high inflation, the Fed’s hawkish tone should have encouraged the EURUSD bears.
At first, the euro bears went ahead, but then investors started selling off the US dollar on facts, and stock buyers were exiting hedges. As a result, S&P 500 surged, and the euro-dollar was jumping up and down.
The euro bulls have a good chance to succeed, which could seem illogical at first glance. The cold winter and the threat of a Russian invasion of Ukraine inflate gas prices and thus exacerbate the energy crisis. The omicron forces governments to impose restrictions, which slows down the economy. The euro area consists of states with different economic development. Unlike the USA, it has Italy, which makes the ECB less flexible than the Fed. In such circumstances, the loss of patience on the part of Christine Lagarde and her colleagues could turn into a surge in bond yields, which will slow down the GDP recovery.
And yet, the ECB still has a chance to give a hawkish surprise. If the policymakers abandon the meaningless phrase about ‘the temporary nature of high inflation and don’t expand the APP, ordinary quantitative easing programme, after the end of the PEPP amid higher inflation forecasts, the EURUSD bulls can well go ahead.
EURUSD trading plan for today
Remarkably, the US dollar appreciated by an average of 4% in the six months before the first federal funds rate hike. This is how much the USD index has risen since June. If the historical event is only three months away, will the dollar be trading flat to continue its rally? The answer to this question will depend not only on the Fed but also on other central banks, including the ECB. In the meanwhile, I recommend moving the stop loss for the EURUSDlongs, entered on the drawdown towards 1.22, to the breakeven and following the potential correction development.
Price chart of EURUSD in real time mode
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