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The ECB can and should cut rates faster than the Fed to prevent the euro area from slipping into deflation. The Federal Reserve can afford to take its time. How does this affect the balance of power in the EURUSD pair? Let’s discuss the Forex outlook and draw up a trading plan.
Weekly US dollar fundamental forecast
Although the EURUSD bulls are willing to reverse the trend, the laws of the economy are in power. Due to weaker consumer activity and GDP, the slowdown in inflation in the euro area is in full swing, unlike in the US, where the process has stalled. This means that market expectations for a faster start to the ECB’s monetary expansion compared to the Fed are justified, as are forecasts regarding the scale of rate cuts. The rise in the EURUSD is nothing more than a correction.
Dynamics of inflation in USA, UK, and euro area
Source: Financial Times.
The European Central Bank forecasts that consumer prices will return to the 2% target in 2025, but according to Bloomberg, they could fall below this level as early as the summer, with CPI slowing to 1.4% by early next year. The ECB knows firsthand how difficult it is to fight deflation. So wouldn’t it be better not to let things get to that point and to ease monetary policy earlier than the markets expect?
Judging by the minutes of the ECB March meeting, wage growth is declining, and companies are increasingly absorbing high labor costs, preventing prices from rising. Inflation is confidently moving towards the target of 2%, which allows us to talk about a rate reduction. The derivatives market expects the ECB to reduce borrowing costs by 90 basis points, while the Fed will cut the rates by only 70 basis points in 2024, which suggests the EURUSD should soon resume the downtrend.
Forecasts for Fed and ECB interest rates
Source: Bloomberg.
In fact, the start of the Fed’s monetary expansion may occur later than June. Thus, Minneapolis Fed President Neel Kashkari said in March that he predicted two rate cuts in 2024. However, if inflation continues to move sideways, he will question whether the central bank should ease the monetary policy at all. Richmond Fed president Thomas Barkin says it’s wise to take things slow and no one wants to see high inflation return. Patrick Harker, the president of the Philadelphia Fed, argues that the Fed is not where it should be and that inflation is still too high and the economy is hot.
The FOMC’s hawkish tone has discouraged the EURUSD bulls. The euro’s three-day rally has quickly finished. However, whatever the Fed thinks now, its opinion may change because of the incoming data. The US jobs report may give a clue on the trend of the US economy.
Weekly EURUSD trading plan
If the US labor market remains strong, the chances that the federal funds rate will fall two or fewer times in 2024 will increase, expectations for the start of monetary expansion will shift from June to July, and EURUSD will continue to fall. Otherwise, a weaker-than-expected jobs report will be the first sign of a cooling economy and will raise the likelihood of a deeper rate cut by the Fed, pressing the US dollar down against a basket of currencies. As long as the euro is trading below $1.0845, it is relevant to sell.
Price chart of EURUSD in real time mode
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