The Fed’s dual mandate sets a difficult task. Inflation is soaring while the labor market is recovering slower than the economy. And this is not the only imbalance. How does the imbalance affect the EURUSD? Let us discuss the Forex outlook and make up a trading plan.
US dollar fundamental forecast for today
Fed’s June meeting will be like walking on a knife edge. If the central bank does too little, US inflation will continue accelerating. If he does too much, the US economy will slide into a financial crisis and recession. Investors are nervous ahead of the important event. After a drop at the end of last week, the EURUSD is trading around the bottom of figure 21.
According to 63% of 224 asset managers with $667 billion assets surveyed by BofA Merrill Lynch, the Fed will signal to taper the QE in September. However, the Federal Reserve’s so-called dot plot could give a clue in early summer. In March, 11 out of 18 FOMC officials predicted a federal funds rate hike in 2024, but successful vaccinations and surging US GDP increase the chance of shifting the date X to 2023.
March forecasts for federal funds rate
Source: Financial Times
Fed is challenged now. If the forecast suggests an earlier start of monetary normalization, investors will think that the central bank is frightened by inflation and will resort to monetary restrictions sooner than is currently expected. If the consensus forecast remains unchanged, investors will believe that Jerome Powell and his colleagues are willing to put up with high inflation. What should the Fed do amid significant imbalances in the US economy? Demand is growing much faster than supply, causing inflationary pressures. The labor market is recovering more slowly than the GDP. Investors were also puzzled by the release of data on retail sales and producer prices. The first indicator dipped by 1.3%, the second – increased by 0.8%, with an average monthly increase of 0.2% in 2017-2019.
The list of imbalances does not end there. The widening twin deficit has been an important driver for the USD for a long time. It has been presumed that US imports exceed domestic production. Therefore, there is the foreign trade deficit, which should be compensated by the capital inflows into the USA. As long as the US is the world leader in terms of vaccination rates and its economy is growing by leaps and bounds, this does not pose much of a problem for the dollar. But as soon as the rest of the world begins to catch up with the USA, as it was in 2014, investors will be selling off the greenback.
Dynamics of US twin deficit
Source: Financial Times
According to Goldman Sachs, the combination of the steady global economic recovery and the Fed’s slow monetary normalization will further weaken the US dollar. In this case, the major beneficiary will be the euro. BofA Merrill Lynch believes that the further EURUSD trend will depend on whether the Fed was right about the temporary nature of the inflation surge. In the bank’s survey, 72% believe that the central bank is correct, but what if there is a mistake? Massive closing of the positions could trigger the crash of the stock indexes and strengthen the dollar. Based on the forecast for the euro at $1.15 at the end of the year, BofA Merrill Lynch believes it is a likely scenario.
EURUSD trading plan for today
The Fed is challenged with a hard task. If the US central bank succeeds, the EURUSD will go back above 1.22. Place your bets, ladies and gentlemen!
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Price chart of EURUSD in real time mode
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