History repeats itself. In mid-August, the EURUSD crashed following the US inflation report for July. This time, the euro bulls have repeated the old mistake. Let us discuss the forex outlook and make up a EURUSD trading plan.
Weekly euro fundamental forecast
In September, US core inflation may slow down, but its acceleration from 5.9% to 6.3% Y-o-Y and from 0.3% to 0.6% M-o-M shocked financial markets. Prices are too high, the Fed should be doing more than it is doing now, which requires higher rates and destruction of demand, increasing the likelihood of a recession in the USA. The US stock indexes featured the worst drop since June 2020, 10-year Treasury yield jumped above 3.4%, sending the EURUSD down below parity.
Stock bulls were overconfident, being sure the US inflation slowdown would make the Fed stop monetary tightening. The 4-day rally in the S&P 500 on the eve of the important news release showed that stock bulls were reckless. In mid-August, the stock market did already crash, and this time, traders repeated the same error. The stock market crashed as well as the EURUSD, and sellers made a good profit.
The S&P 500 will hardly enter a bull market. The Fed pursues aggressive monetary tightening, US GDP is slowing down, and corporate profit forecasts, according to FactSet data, fall. History shows that downtrends in US stock indices were accompanied by outperforming consumer prices over economic growth, as was the case, for example, in the 1970s and early 2000s. The same trend is taking place at the present time.
Dynamics of S&P 500, inflation and GDP in USA
When investors sell stocks and bonds, driving up the yields of the latter, the only option left is to buy the US dollar. It is not surprising that the USD index, against the backdrop of an unexpectedly fast acceleration in core inflation in the United States, marked the best daily gain since March 2020. The probability of a 50-basis-point increase in the federal funds rate at the FOMC meeting on September 20-21 fell to zero, while the chances of its growth by 100 basis points, which has not been seen since at least the 1990s, jumped from zero to 34%. Furthermore, Nomura believes a 100-basis-point rate increase is a basic scenario.
I don’t think the Fed will hike the rate by 100 basis points. If it does, it will be interpreted as a panic because of rising inflation. However, a 50-basis-point rate hike is also unlikely. In late 2021, the Fed acted according to the principle “prove that high inflation is really stable”; now, it is guided by the principle “prove that high inflation is about fall”. The derivatives market price in a federal funds rate growth to 4.3% in early 2023, so the EURUSD downtrend is stable.
Weekly EURUSD trading plan
I don’t think the EURUSD bears will go ahead right away, being cautious ahead of the FOMC meeting. Hold down the shorts entered on the rebound form 1.018 and add up to them on corrections. The first target is 0.97.
Price chart of EURUSD in real time mode
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