The increase in the federal funds rate, coupled with Kevin Warsh’s hawkish rhetoric, surprised speculators who had been selling the US dollar for seven consecutive weeks. Let’s examine the situation and develop a trading plan for the EUR/USD pair.
The article covers the following subjects:
Major Takeaways
- The dollar posted its best performance in three weeks.
- The Fed didn’t just raise rates—it also restored confidence.
- Other central banks are not going to stop there.
- Long positions can be opened above 1.1495.
Weekly Fundamental Forecast for Dollar
Kevin Warsh made a significant move. His hawkish rhetoric after the September FOMC meeting removed an obstacle to buying the US dollar while also creating a barrier to selling it. Speculators who had been selling the greenback for seven consecutive weeks ahead of the Fed meeting were caught off guard, triggering the EUR/USD pair’s sharpest decline in three weeks. However, the market needs additional bearish momentum for the downtrend to extend.
Speculative Positions on US Dollar
Source: Bloomberg.
The Fed raised interest rates despite Donald Trump’s objections. This proved sufficient to restore confidence not only in the central bank but also in US assets. The Fed has joined other major central banks, including the ECB and the Bank of Japan, in tightening monetary policy to combat inflation. According to Brown Brothers Harriman, the US Dollar Index is unlikely to reach new cyclical highs, as competing central banks are also maintaining a tightening bias.
Over the next 12 months, derivatives markets are pricing in two Fed rate hikes, with some probability of a third. The ECB is also expected to deliver two hikes, while the probability of a third is estimated at more than 50%. Investors expect the Bank of Japan’s overnight rate and the Bank of England’s repo rate to rise by 75 basis points, with the latter potentially increasing by as much as 100 basis points. In other words, the dollar is not benefiting from the relative pace of monetary tightening. Moreover, with the outcome of the FOMC meeting already priced in, the EUR/USD pair could be poised for a short-term corrective rebound.
The major currency pair has managed to stabilize, partly due to the USD/JPY rally triggered by investor disappointment with the divided Governing Board’s decision on raising the BoJ’s overnight rate from 1% to 1.25%. Against a backdrop of low volatility and strong global risk appetite, the carry trade is flourishing. The yen’s recent appreciation prompted carry traders to temporarily turn to the euro as a funding currency. Once the yen weakened again, the market largely returned to its previous positioning, providing additional support for the euro.
EUR/USD Volatility
Source: Bloomberg.
However, the euro still faces significant vulnerabilities, including political risks in Germany and France, as well as the looming threat of an energy crisis. It is far from certain that the eurozone economy will be able to withstand higher ECB interest rates to the same extent that the US economy can absorb higher Fed rates.
Moreover, the US dollar could regain its key advantage: American exceptionalism. All it would take is PMI data showing that the US economy is outperforming its European counterpart.
Weekly Trading Plan for EUR/USD
The EUR/USD pair’s downtrend may continue, although the risk of a short-term rebound cannot be ruled out. If the price breaks through 1.1495, this could signal an opportunity to buy the euro, while a rebound from 1.1505, 1.1540, or 1.1555 could provide opportunities to sell it.
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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