The major currency pair is poised to resume an upward trajectory as investors shift their focus to the divergence in monetary policy between the ECB and the Fed. Let’s delve into this topic and make a trading plan for the EURUSD pair.
The article covers the following subjects:
Highlights and key points
- The US PPI slowdown has pushed the EURUSD pair to August highs.
- The market expects a 50 bp Fed rate cut in September.
- ECB’s slowness favors the euro.
- The EURUSD pair may consolidate above 1.1015.
Weekly fundamental forecast for euro
On a positive note, there has been no stagflation. Following the release of data on US producer prices for July, investors revised their outlook and initiated purchases of stocks and bonds. Stock indices increased, while yields on US Treasuries dropped, setting the stage for EURUSD bulls. The pair pierced the 1.0945 level and surged to seven-month highs in an attempt to reinforce the uptrend.
The US Producer Price Index (PPI) increased by 0.1% in July, while the core indicator remained flat on a monthly basis. Producer prices rose 2.2% and 2.4% year-over-year, continuing the disinflationary trend. This increased the likelihood of a 50 bp cut in the federal funds rate in September, from less than 50% to 55%, and fueled the EURUSD rally. According to Deutsche Bank, there will be a lively discussion at the upcoming FOMC meeting on how much to cut borrowing costs: half a point or a quarter?
US Producer Price Index change
Source: Bloomberg.
The acceleration in PPI may have heightened concerns about the potential for stagflation, a scenario in which economic growth decelerates while prices increase. The market continues to monitor recession risks, which Goldman Sachs has identified as increasing from 29% to 41% based on stock and bond indicators. A comparable JP Morgan model indicates that the probability of an economic downturn in the US has soared from 20% to 31%. As anticipated, derivatives are increasing the likelihood of a 50 bp cut in the federal funds rate in September, necessitating a support measure from the Fed. All of these are creating a tailwind for the EURUSD.
US recession odds
Source: Bloomberg.
The futures market expects anticipate that the Fed will implement a 100 bp reduction in its monetary policy in 2024. This is a notable shift from the 50 bp cut in the deposit rate that Reuters experts have projected. According to the opinions of 66 out of 81 experts, the European Central Bank will take two further steps on the road of monetary expansion, in September and December. Five respondents indicated that one act would be sufficient, while eight respondents indicated that three cuts would be necessary.
Despite the eurozone economy’s current weakness, wages in Germany are expected to rise by 5.6% in 2024. The indicator is expected to grow at the fastest pace since the turn of the century, which could lead to a return of high prices and give the ECB reason to proceed with caution in its monetary policy easing. As a rule, the EURUSD pair benefits from monetary policy divergence between the ECB and the Fed.
Deutsche Bank seems to be overly hasty in its assessment. The September FOMC meeting will focus on the question of whether to cut rates rather than on the size of the cut. The market is overestimating the likelihood of decisive action from the Fed, and the increase in volatility as the US presidential election approaches will provide support for the US dollar.
Weekly trading plan for EURUSD
Long trades opened at 1.0945 have brought profits. The pair may surge to the August high ahead of the CPI data release. However, consider selling the EURUSD pair if it fails to consolidate above 1.1015 and 1.104.
Price chart of EURUSD in real time mode
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