US inflation data made the market believe that the Fed would raise the rate by a quarter of a point in February and finally destroyed investors’ faith in the US dollar. Let’s discuss this topic and make up a trading plan for EURUSD.
Monthly US dollar fundamental forecast
Financial markets reacted to the sixth consecutive slowdown in US inflation much calmer than the previous five. The S&P 500 marked the smallest daily rally since April, while EURUSD declined after soaring to 9-month highs. Traders are gradually getting used to the easing of price pressure and are becoming more and more convinced that the Fed will move from raising rates to lowering them sooner or later. For most of 2022, the Fed often won battles against the markets. In 2023, the initiative passed to investors.
S&P 500 reaction to US inflation data
Source: Bloomberg.
The consumer price growth decline from 7.1% to 6.5% YoY and from 0.1% to -0.1% MoM, together with the core inflation slowdown from 6% to 5.7% YoY, is another confirmation that CPI has peaked. Inflation has fallen, which allows the Fed to reduce the monetary tightening rate and undermine the USD position. CME derivatives raised the chances of the federal funds rate rise by 25 bps in February from 77% to 95%. The heads of the Philadelphia and Boston Federal Reserve Banks, Patrick Harker and Susan Collins, agreed that 25 bps is the best option.
US inflation dynamics
Source: Bloomberg.
Curiously, most of the inflation turned out to be rolling, as Fed officials said at the end of 2021. Does this mean that they are not mistaken? No! If not for rejecting the old mantra and the transition to aggressive monetary restriction, consumer prices would hardly have slowed down so rapidly. The Fed is afraid to repeat the mistake of the 1970s when the euphoria over the victory over inflation forced the central bank to turn soft. This eventually led to a new price increase. Markets are confident that CPI will continue to decline. Therefore, the divergence of views is the main reason for the conflict between investors and the Fed.
The markets don’t believe the Fed not because of its past mistakes. Investors are aware that monetary policy depends on data. Its variability can fundamentally affect forecasts and the central bank’s final decisions. In addition, everyone is well aware that the Fed needs to turn hawkish because, according to the most optimistic estimates, PCE will not fall to the 2% target. Inflation will remain at higher levels than before the pandemic, which means that the work of the Fed will remain unfulfilled for a very long time.
However, no matter how much USD buyers rely on rising core inflation by 0.3% MoM, rising service prices, and labor market strength, it is clear that the USD is no longer the king of the market. It’s time for the euro to rule!
Monthly EURUSD trading plan
The fact that EURUSD did not reach the important levels of 1.08 and 1.082 made the idea of taking profits on long trades entered at 1.069 unreasonable. Now it makes sense to add up to them on corrections. Levels 1.095 and 1.104 serve as the main targets for the EURUSD uptrend.
Price chart of EURUSD in real time mode
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