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Markets agree with the Fed on the scale of monetary expansion. But despite the same forecasts for the economy, scientists do not agree with the central bank. If they are right, the EURUSD will continue to fall.
Weekly US dollar fundamental forecast
Fear and Greed are ruling the market. When the Fed made a dovish shift at the end of 2023, signaling a cut in the federal funds rate at three FOMC meetings in 2024, markets saw six acts of monetary expansion. Treasury yields and the US dollar collapsed. However, in the first quarter, investors curbed their appetites, allowing them to recover. Derivatives see borrowing costs falling by 75 basis points and give a 75% chance that the Fed will make its first move in June. The market agrees with the central bank. However, economists suggest a different scenario, which means the EURUSD will continue falling.
People make decisions. The FOMC members are more risk-averse than academic economists. 72% of 38 Financial Times respondents see no more than two cuts in the federal funds rate in 2024. At the same time, the views of experts and the Federal Reserve on economic growth and unemployment are completely consistent. In terms of inflation, they are almost no different.
Forecasts for scale of Fed’s monetary easing
Source: Financial Times.
Forecasts for US GDP, unemployment and inflation
Source: Financial Times.
It is believed that monetary policy affects the economy with a time lag of approximately 18 months, so waiting for inflation to come down to the 2% target is not a good idea. Keeping high rates on a plateau for an extended period could trigger a recession. However, too early monetary easing risks the return of inflation. The Fed is willing to take more risks than academic economists, and the central bank supports the market. But what will happen if the US domestic data continue to strengthen and CPI and PCE draw a new peak?
The Fed plans to cut borrowing costs by about 200 basis points in the cycle so that when inflation is anchored near 2%, the real rate is about 0.5%. However, if the US economy remains strong, most of the cuts will occur in 2025-2026. What does this mean for the market? Treasury yields and the US dollar will continue to rise, just as they did in January-March.
Is this process endless? Of course not. The US economic performance may begin to steadily worsen. Or the strength of the US economy will give momentum to the global economy. At the same time, the acceleration of global GDP will support such a pro-cyclical currency as the euro. On the contrary, the rise to power of Donald Trump, the revival of protectionist policies, and the associated slowdown in the economies of China and the EU will force investors to buy the greenback as a safe-haven currency.
Weekly EURUSD trading plan
Time will tell according to which of the two scenarios, optimistic or pessimistic, events will develop. In the meantime, the chances that the Fed will cut interest rates once or twice in 2024 are higher than the probability of lowering borrowing costs by 1% or more. Therefore, the EURUSD is likely to fall to the previously indicated target of 1.07. I suggest holding down the shorts entered on the rebound from 1.085 and adding up to them from time to time.
Price chart of EURUSD in real time mode
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