According to the dollar smile theory, the USD index rises during recessions or periods of strong US economic growth. Stagflation is neither extreme, which weakens the greenback. Let’s discuss it and make a trading plan for EUR/USD.
The article covers the following subjects:
Major Takeaways
- Donald Trump placed his own pick on the Fed’s Board of Governors.
- Historically, the US dollar tends to fall during stagflation.
- Hedging is weighing on the USD index.
- A breakout above 1.17 is a signal to build up EUR/USD longs.
Weekly Fundamental Forecast for Dollar
If you want to survive, you have to adapt. If you want to thrive, you have to be able to turn things around. Donald Trump’s nominee for the FOMC Board of Governors, Stephen Miran, once actively criticized the Fed’s “doves.” In his view, the central bank unjustifiably cut rates in 2024, focusing more on the labor market than inflation. However, the head of the Council of Economic Advisers has since reversed his stance.
Miran now believes Trump’s policy of tax cuts, deregulation, and increased energy production is disinflationary, offsetting any price growth driven by tariffs. Placing a White House insider on the FOMC deepens divisions within the Fed and will likely result in several rate cuts in 2025. It’s no surprise the US dollar lost nearly all of its gains on the news, while EURUSD keeps pushing toward 1.17.
Recurring Jobless Claims
Source: Bloomberg.
Inflation expectations for the next year have risen from 3% to 3.1%, and five-year expectations are up to 2.9% — the highest since February. At the same time, repeat jobless claims have hit their highest level since November 2021, all pointing to looming stagflation in the US. This scenario is unfavorable for EURUSD bears.
According to the dollar smile theory, the USD index strengthens when the US economy is either booming or in crisis. In the first case, the “American exceptionalism” factor attracts capital inflows; in the second, the greenback benefits from its safe-haven status.
In 2025, neither extreme is in play. The labor market and economy are slowing, while prices are rising. Stagflation hits US stock indexes and prompts capital outflows from America. Any success by EURUSD bears is likely to be short-lived, as the uptrend still holds.
Currency-hedging flows from non-residents holding US assets play a key role. Their slowdown in late July and early August triggered a EURUSD pullback. However, labor market weakness and ongoing White House policy uncertainty are pushing overseas investors to sell the US dollar as a hedge.
At first glance, a further acceleration in US inflation could change the picture. In reality, it won’t. Such price dynamics would only confirm the stagflation scenario for the US economy and create opportunities to buy EURUSD on pullbacks. The Fed is likely to cut the federal funds rate in September, and expectations of renewed monetary easing will keep pressure on the greenback.
Weekly Trading Plan for EURUSD
Despite the bears’ counterattack, EURUSD longs opened from 1.155 and 1.16 remain relevant. A move above 1.17 will be a signal to build up positions.
This forecast is based on the analysis of fundamental factors. It considers official statements by financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also taken into account.
Price chart of EURUSD in real time mode
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance broker. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2014/65/EU.
According to copyright law, this article is considered intellectual property, which includes a prohibition on copying and distributing it without consent.
