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The acceleration of consumer and producer prices in the US raises the chance of revising FOMC rate expectations in December. What will the Fed do? Let’s discuss it and make a trading plan for EURUSD.
Weekly fundamental forecast for dollar
What’s important to the market that buys on rumors and sells on fact? What exactly will the Fed do with rates? How will it signal its intention? Expectations of the revision of the FOMC’s March forecasts from three to two monetary expansion acts in 2024 triggered a rally in treasury yields. As a result, the US dollar has grown, and the EURUSD collapsed below 1.09.
If the Fed is a doctor and policy tightening is a medicine, nothing can be worse than discontinuing therapy and seeing the disease come back. The rise in US consumer prices was followed by an acceleration of US producer prices: they grew by 0.6% m/m and 1.6% y/y in February, while core PPI jumped to 2% y/y. Based on these indicators and the CPI, Pantheon Macroeconomics expects PCE to rise by 0.4% m/m. Barclays Plc and Bank of America expect the PCE, the Fed’s preferred inflation indicator, to increase to 0.3% m/m and 2.8% y/y.
US inflation trends
Source: Bloomberg.
Disinflationary processes in the United States have hit the brakes, giving the Fed the foundation to keep rates at a plateau for a long period. Nomura’s updated forecasts presume only two acts of monetary expansion in 2024 — in July and December — compared to three acts in previous estimates. Santander US Capital Markets believes the fed funds rate will remain unchanged until November.
Investors agree with the Fed’s slower policy easing. They have poured money into last year’s stellar money market assets for three consecutive weeks, hitting a record $6.108 trillion by now. Such expectations indicate that US borrowing costs will remain on a plateau longer than the derivatives market anticipates.
Evolution of money-market assets
Source: Bloomberg.
Even if the Fed has reasons to live up to expectations of a slower policy easing, will it want to do so? The risks have not vanished. We may have a new inflation peak if rate cuts occur earlier than necessary. If rates are held on low levels longer, a recession may occur, and the US economy will start showing signs of cooling.
Retail sales in February turned out worse than Bloomberg anticipated, and January figures were revised to a deeper decline. Moreover, control-group sales, used to calculate consumer spending and GDP, remained unchanged. Americans are becoming harder to please, raising the risk of a serious economic slowdown in the first quarter. Could that be a foundation for cutting the extremely high fed funds rate?
Weekly trading plan for EURUSD
The market seems to have concluded that a decline in GDP growth pace will be the lesser evil than inflation acceleration. It started to sell the EURUSD, counting on the revision of the FOMC’s rate expectations in March. The strategy of selling the euro from $1.097 with a subsequent build-up of positions from $1.0945 remains valid. Continue selling.
Price chart of EURUSD in real time mode
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