Contrary to expectations, the greenback is gaining strength rather than weakening following the Fed’s rate cut. The ECB and the Bank of Japan’s decision to maintain a neutral stance has boosted the USD index. The Forex market continues to demonstrate contradictory trends. However, there is a reasonable explanation for everything. Let’s discuss this topic and make a trading plan for the EUR/USD pair.
The article covers the following subjects:
Major Takeaways
- With no surprises from the ECB, the euro tumbled.
- The eurozone economy showed signs of improvement.
- Uncertainty is helping the US dollar.
- Short trades on the EUR/USD pair can be opened on a breakout of 1.155.
Weekly US Dollar Fundamental Forecast
The Fed’s hawkish rhetoric and the emergence of a dissenting vote in favor of maintaining the federal funds rate caught the markets off guard. Against this backdrop, the US dollar surged. Neither the ECB nor the Bank of Japan managed to surprise investors. The financial regulators refrained from signaling any changes in monetary policy in the future. The euro and the yen fell. Sometimes, the Forex market resembles a spoiled child, needing treats and some freedom to misbehave from time to time.
From a theoretical standpoint, the current situation on Forex can be described as a paradox. The interest rate spread between the Fed and the ECB is narrowing, and the eurozone economy unexpectedly accelerated from 0.5% to 0.9% in the third quarter. However, instead of starting a rally, the EUR/USD pair is plunging. Apparently, the fundamental principle of “strong economy – strong currency” has lost its relevance for the time being.
Fed and ECB Interest Rates
Source: Wall Street Journal.
In general, everything follows a logical sequence. EU GDP is showing signs of growth as it adjusts to US tariffs. The eurozone suffered the greatest damage from US import duties in the second quarter. Notably, Christine Lagarde stated that complaints about the economy held no merit. However, new trade agreements have reduced uncertainty. Finally, solid private sector balance sheets and the robust labor market were among the most influential factors, as was the effect of a 200 basis point reduction in deposit rates during the recent monetary policy cycle.
Meanwhile, the United States maintains a strong stance. According to a leading indicator from the Federal Reserve Bank of Atlanta, US GDP is expected to expand by 3.9% in the third quarter. It is clear that there is no evidence of a narrowing divergence in economic growth.
Regarding monetary policy, investors should understand that markets tend to grow on expectations. The rally in EUR/USD quotes from early August to mid-September was driven by the speculation that the Fed would cut interest rates, while the ECB was expected to keep them unchanged. As a result, when the Fed resumed its cycle of monetary policy easing, profit-taking began, and the euro tumbled by 3%.
Market Expectations for Fed Rate Cut in December
Source: Wall Street Journal.
At the same time, the derivatives market has reduced the likelihood of a sharp cut in federal funds rates in December from over 90% to 67%. The question is, when will this reassessment end? As a rule, this decision is based on incoming data. However, the lack of data due to the shutdown is forcing the Fed and the markets to only guess about the future. The fog of uncertainty is becoming denser. The US-China trade agreement is essentially a temporary truce, and the government shutdown persists. In November, the Supreme Court will rule on tariffs, and if they are canceled, it will cause tremendous market chaos.
Weekly EURUSD Trading Plan
Assuming that confidence in the US dollar has been restored, the increase in uncertainty is a reason to buy it. The ECB did not make any unexpected shifts, and the EUR/USD pair slid toward 1.155. If this level is broken through, short positions can be considered.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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