Against the backdrop of persistent disinflation and disappointing employment statistics, the Fed is starting to express concern about the labor market. Investors should watch for shifts in the central bank’s priorities. Let’s discuss this topic and make a trading plan for the EURUSD pair.
The article covers the following subjects:
Highlights and key points
- The market had a subdued reaction to the US inflation data.
- The Fed is starting to focus more on employment than on CPI and PCE.
- Unemployment claims may increase volatility in the EURUSD.
- Strong data will allow traders to build up short trades on the euro formed at 1.104.
Daily US dollar fundamental forecast
The market considers all relevant factors. The market’s reaction to the release of US July inflation data indicates that the Fed should consider other indicators in its assessment. The derivatives market reduced the odds of a cut in the federal funds rate in September by 50bps from 50% to 35% following the release of consumer price data, which showed prices falling below 3% for the first time in three years. It is unlikely that the PCE and CPI figures will prompt a change of stance, but the employment data may do so. This factor may trigger wide fluctuations in the EURUSD pair.
The relatively subdued market response to the decline in consumer prices to 2.9% and core inflation to 3.2% year-on-year suggests that investors’ primary concern was a recession in the US economy. If the CPI had also grown, it would be possible to discuss the possibility of stagflation and the demand from the Federal Reserve to reduce borrowing costs. In the meantime, the central bank is set to cut the federal funds rate by 25 bps to 5.25% in September and is awaiting fresh data on the US labor market.
US inflation rate change
Source: Wall Street Journal.
Austan Goolsbee, head of the Chicago Fed and one of the FOMC’s confirmed doves, has expressed concern about the US employment, citing progress on inflation and a disappointing jobs report as factors that have prompted this shift in focus. His counterpart at the Atlanta Fed, Rafael Bostic, is open to a cut in the federal funds rate in September, emphasizing the importance of acting promptly. It must fulfill its primary objective to return the PCE to the 2% target and avoid the rapidly cooling labor market.
CME Derivatives anticipates a 32bp decline in borrowing costs by the end of September, a 67bp reduction by the end of October, and a 103bp cut by the end of the year. This suggests that monetary policy may ease by half a point at two out of three FOMC meetings.
Federal funds rate expectations
Source: Bloomberg.
Meanwhile, the derivatives market is projecting a 70bp reduction in the ECB deposit rate in 2024 at two out of three Governing Council meetings of 25 bps at each, with a high probability at the third one. The differing rates of monetary expansion and potential improvement in global risk appetite give ING reason to expect the EURUSD rally to continue towards 1.12. Conversely, DZ Bank believes that market estimates of the extent of the Fed’s monetary policy easing this year are overstated and that the German economy is too weak to expect a sustained strengthening of the euro. Therefore, the major currency pair may see a large sell-off.
Daily EURUSD trading plan
Should narratives evolve and both the markets and the Fed shift their focus from inflation to employment, it is possible that unemployment claims data may prompt a more pronounced investor response than consumer price data. An uptick in the US labor market will allow traders to open short trades on the EURUSD pair, adding them to the ones initiated at 1.104.
Price chart of EURUSD in real time mode
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