The Fed will tolerate high inflation for at least three months before starting to discuss tapering the QE. If so, the market’s reaction to the CPI looks too emotional. Investors need to calm down. How will it affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
Weekly US dollar fundamental forecast
Investors often act on emotions. The main reason for the 4.2% surge in consumer prices in April, which exited investors, was the 10% increase in used car prices, the fastest since the 1950s. Will the Fed cool down a single sector by raising rates and put pressure on the rest of the economy? The US economy, according to the jobs report, hasn’t yet recovered. The Treasury yield surge and the S&P 500 drop looked too emotional. Now, it is time for revising the investment ideas.
I believe the current Fed’s strategy is correct. The central bank tries to project realistic confidence in the inflation outlook combined with a willingness to take action if anything changes. The FOMC officials say the US economy is getting overheated, but the central bank needs several more months of data on employment and inflation before deciding when to end the easy money policy. As a result, The median of the US. consumers surveyed by the University of Michigan in April expect inflation of 3.4% over the next year, then dropping to 2.7% in the next five to 10 years.
The same thing happens with market inflation expectations, the longer the term, the lower they are.
Dynamics of inflation expectations
What level of the personal consumption expenditures price index will force the Fed to take action? The median gauge of Reuters experts suggests the US policymakers will feel discomfort when the core PCE hits a high of 2.8%. 36 out of 41 experts believe that the indicator should be at this level for at least three months before the central bank begins to act. In March, the threshold was 1.8%.
Thus, the surge in Treasury yields in response to the CPI acceleration to 4.2% in April was another test of the Fed’s strength, but gradually the market realizes that the Fed will hardly taper the monetary stimulus soon. I wonder why the 10-year Treasury yield is close to March highs but the EURUSD is trading at 1.21 up from 1.17 in March. The answer is simple, the euro-area economy is much stronger now than a couple of months ago.
Most 10-year government bond yields in the euro area increased, only Germany’s 10-year Bund yield remained below zero. BofA Merrill Lynch argues that the major reason for the euro-area bond yields rise is the US economic rebound. However, the increase in the vaccination rates suggests the euro-area economy is about to rebound. The European Commission lifts the euro-area GDP forecasts for 2021 from 3.8% to 4.3%. The euro should continue the rally amid Germany’s elections. The Greens, leading in the polls, could further push both country and continent toward the U.S. model of aggressive government stimulus, contributing to the integration of the euro area.
Weekly EURUSD trading plan
Therefore, the current market swings will hardly force the Fed to change its policy, which, coupled with the positive signals from Europe, should suggest the EURUSD uptrend recovery. If the euro breaks out the resistance at $1.211, it will be relevant to enter longs.
Price chart of EURUSD in real time mode
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